JumpStart: IdeaExchange Blog

When entrepreneurs are frustrated with the terms they are offered by investors, they should find other investors who will invest on better terms. Simple, right? Not so much. In many cases, entrepreneurs are already locked into an exclusivity clause, at which point it is indeed advisable (from a legal standpoint, if nothing else) that they do not go find other investors. The “Exclusivity” clause of a term sheet is a common clause, and though some investors abuse the clause, using it to lock in an eager, cash-low entrepreneur (too) early, the vast majority use it properly: they do as much due diligence as possible before issuing the term sheet, and then issue the term sheet only when they are prepared to go into a brief (4-6 weeks) period of legal documentation. At this point, the legal costs begin and the investor wants to make sure the entrepreneur is motivated to get the investment closed quickly. The time to court other investors is over.

Entrepreneurs should realize that investors issuing the term sheet not early but rather towards the middle or end of due diligence is a good thing; it is not intended to string out the entrepreneur. It allows the entrepreneur to continue seeking other investors until one firm is truly ready to commit, and therefore allows the entrepreneur to try to “create a market for their securities” (which theoretically increases the price of the deal). To play this dynamic right, though, entrepreneurs should try to get as many investors as possible interested in their company, get from the investors the likely terms (without formally getting a term sheet), and then get a term sheet only when the entrepreneur is very comfortable with what the terms are likely to be. By the way, I think investors who do not require exclusivity in a term sheet are wise and brave: my compliments. I like to think that if I were an early-stage, for-profit investor, this is what I would do, but I understand all the upsides and downsides of this non-standard path. (JumpStart Ventures’ term sheet is non-exclusive, btw).

In one instance I have done the opposite of this advice, and that was in a case where, as an existing investor, I very quickly needed the physical proof of a signed term sheet to show other existing investors that new investors did indeed want to invest in the company in question. Speed was required, and I advised an entrepreneur to sign an exclusive term sheet very early in the game with virtually no due diligence completed. Long story short: while not perfect, this tactic did do the job. (Playing soon in theatres near you…Coming to Terms: War Stories from Cleveland’s Economic Development Jungle, directed by Quentin Tarantino and starring Angelina Jolie and Ralph Fiennes).

So, in summary, try to avoid an exclusivity clause in your term sheet, but since these are not unusual, just try to optimize the timing of getting the term sheet issued (they usually expire if not signed within a week, so you don’t even want it issued, never mind signed, too early). Work it out so the term sheet is mutually signed as late as possible and when you really want to lock into one investor. Before signing, ask the investor what the average timeline is from term sheet to close. Ask them when they’ve seen it extend and why. If an investor is pushing you to sign way earlier, without giving any signs of likely terms and without having done much due diligence, I’d suggest moving on. Unless you have no cash, in which case the terms are the terms are the terms.

Finally, though it’s cold comfort in the heat of a deal, remember that you don’t have to take a term sheet at all. It’s a free country, and it is your decision to start a company that doesn’t get money the traditional way (i.e., through customers, bank loan, etc) and that must use a statistically rare type of capital — OPM* — to become successful.**

(Here is one good resource on the exclusivity clause in a term sheet – venture capital for the serious entrepreneur).

* “Other Peoples’ Money”

** Attention Scriptwriters: please punch up this killer last line so that it’s in the voice of Angelina. She wouldn’t say “statistically rare type of capital”. Or maybe she would; she’d just be wearing a cat suit and carrying an Uzi as she said it. 

Most marketers dream about having oodles of market research to direct their activities, and most of us (probably all of us) get used to not having it — or at least, not oodles. But one of the best things about blogs and other Web 2.0 communities is that you can get feedback — directional, for sure — quickly and easily. A dream come true! So I’ve been thinking about one of JumpStart’s opportunities lately and could really use your help and feedback to shape it.

Last year, JumpStart kicked off a new series of lunch seminars, called Growing Bright Ideas, focused on topics relevant for early-stage technology entrepreneurs leading high growth companies. As a quick recap, here were the topics:

1. Technology Marketing: Crossing the Chasm (June 2008)
2. New Media: Tricks of the Trade (August 2008)
3. Founder Frustrations, CEO Mistakes (November 2008)
4. Hiring Smart: Advice for Hiring Top Talent (December 2008)
5. Fundraising: What you Must Know (March 2009)
6. The Term Sheet: What you Must Know (April 2009)

Sound familiar? I hope so. Some of my personal highlights from the seminars include: enjoying HBS Professor Noam Wasserman’s slides with super-hero characters as the proxy for entrepreneurs (yeah!), laughing at Bonnie Gwin’s stories about interviewing candidates for positions, learning the “real deal” on negotiating term sheets from Steve Lindseth and John Saada, and getting to meet new folks joining our Northeast Ohio entrepreneurial community in every seminar.

We are in the process of planning for next fall’s seminars, and this is where I start dreaming about getting some feedback on where to take the series. There are three questions that your answers to would be really helpful:

1. What topics would be most interesting to you that we cover next year (and aren’t being offered elsewhere?)
2. Are you interested in a “101″ level program, or something more advanced?
3. What else should we be considering? (bigger venue, more podcasting of the seminar topics, having the seminars over breakfast, etc)

If you are an entrepreneur leading, or interested in leading, a high growth early-stage technology company, please let me know how we can evolve this series to meet your needs.

Cathy Belk is the Chief Marketing Officer of JumpStart. She specializes in branding, marketing communications, and business management. She brings 16+ years of experience in a variety of marketing and business roles, but gets her energy from working daily with entrepreneurs and their growing companies.

Though he was kinda slow and none too bright**, Microsoft co-founder, Bill Gates III did have one great asset: his father was a small business lawyer. Bill Jr. purportedly helped the teenage Bill negotiate phenomenally well on behalf of his fledgling software company and himself. Without his father’s guidance, would Bill have owned less than the 64% of the company that he started out with (Ballmer had 36%)? The world will never know, but I suspect so — my guess is he might have gone with the old 50/50 split that co-founders often agree on. (See this history here which I took straight from Noam Wasserman’s fabulous Founder Frustrations blog, where he discusses, among other things, the Microsoft Founders.)

Of course, most entrepreneurs have more upstairs than did/does Bill***. Despite their greater natural advantages, they should still make sure that they have a great lawyer. So, how do I define great lawyer? To my mind, for companies that are trying to raise equity capital (angel or venture capital), a good lawyer is someone who has done at least five angel/venture equity deals in the past two years, and a great one is someone who, at a minimum, has done ten.**** In other words, representing companies, founders and investors in angel and venture capital transactions should be a core part of what they do every day, rather than being an occasional thing they do when business is bad or when a friend asks them to help him/her out. Great lawyers for companies who want to take the equity-funding path are up on the latest deal terms. They have been privy to many different negotiating styles, have seen how different investors react to different “hot button” issues, and can bring this expertise to bear when negotiating on your behalf.

Also, figure out how to get some kind of a special deal from them — whether that’s having them offer extra services, like attending board meetings free of charge, taking deferred payment based upon some future funding event, or taking stock options as a form of payment. What I have found is this: lots of top lawyers are incredibly interested in working with entrepreneurs because they’ve seen how successful some early-stage company clients become, and they want to keep working with those kinds of companies. They know that the economics of early-stage companies require some special deal. And, sometimes, if you and your company truly seem high potential they’re willing to offer it. That’s a key point; top lawyers don’t offer special services for undifferentiated companies and entrepreneurs who just want a discount ‘cause they want a discount; rather, great lawyers are willing to “pay it forward” through right-sized economics and special services if they see the potential for payback in you and your business.

My final comment is that I have fully stolen this theme of hiring a great laywer from my esteemed and wise colleague, Lynn-Ann Gries – see her blog on similar subject here.

Notes:

* Disclaimer: I am not married to a lawyer nor do I have a lawyer in my immediate family. I have not been paid by the Cleveland Bar Association to post this blog. I do not get any kickbacks from lawyers. Indeed, I have practically no lawyer friends from whom I could get kickbacks, and since I recommended that you ask them for a discount for them to work for your tiny baby company (GE your company ain’t—might be one day, but it ain’t right now) lawyers probably aren’t that thrilled with me anyhow and will only give me the “kick” part of the “kickback”. Indeed, this posting is just my heartfelt and experienced-based belief about one key aspect of starting and growing a company.

** That’s sarcasm.

*** Ditto - sarcasm.

**** By the way, just because they’ve worked on at least ten angel/venture deals in the past two years (note: ask them specifically for their track record and ask for names of clients or references) doesn’t make them great, but at least it puts them in the running.

***** Here’s another article that gives some more advice on hiring good or great lawyers.

Becca Braun is President of JumpStart Ventures. She founded and led a number of early-stage companies and organizations, as well as worked as a private equity investor and management consultant. She received her MBA from Harvard Business School and her BA in Linguistics from Harvard University. She is keenly interested in the intersection of wealth creation and broad-based regional economic growth.