A Term Sheet is Not a Deal

First the good news. If you get a signed term sheet with a reputable angel or venture investor, there is a very good chance you will get a deal done. Unless, of course, you don’t.

Probably the most common element of every term sheet is the provision that states unequivocally that by signing the term sheet neither party is obligating itself to enter into an investment transaction, whether on the terms reflected in the term sheet or otherwise. Still, if the parties do reach agreement on a term sheet, there usually is a deal made, and usually on terms mostly consistent with the term sheet. That said, herewith a look at the most common reasons a “done term sheet” does not lead to a “done deal.”

  1. The investor can’t build a syndicate sufficient to close the deal out. As they teach you in entrepreneurship boot camp, getting a deal done is first about finding a lead investor. Someone credible who can put a stake in the ground and then help the entrepreneur close a syndicate around that stake. If your lead investor is a top tier fund, or even a second tier fund committed to invest 75% or more of the minimum closing amount, chances are somewhere between no-brainer (top tier fund) and highly likely (second tier fund) that you will get the deal done. On the other hand, if your lead investor is an anonymous angel committed to take only 35% of the minimum-closing amount, don’t hold your breath. The take home point here: your chances of turning a term sheet into a deal are pretty closely tied to the market credibility and relative capital commitment of the investor that signed the term sheet.
  2. Deal due diligence uncovers a major issue that either can’t be suitably resolved, or reflects badly on the entrepreneur’s competence. All-too-common issues that come up in due diligence include IP ownership issues (e.g. important IP was developed without appropriate work-for-hire or assignment documentation) and capitalization table issues (e.g. equity distribution is not well-documented; potential claims for significant equity outside of the cap table turn up; previous investors were unaccredited, or paid too high a price). The take home point here is get your due diligence ducks lined up (and shot, if they need shooting) before you sign the term sheet. Investors – good ones, at least – don’t like surprises, particularly when they suggest a careless, clueless or deceptive entrepreneur.
  3. In the rush to get the term sheet done, one of the parties punted on an important issue, figuring that she could take care of it in the fine print of the closing documents. For example, I once saw an investor leave the question of subjecting some of the founder’s stock to vesting for the closing documents. The very fact that the investor thought avoiding the issue at the term sheet stage was a good idea shows what a bad idea it was. A simple lesson: if an issue is material to either party, deal with it in the term sheet. It may kill the deal, but it will save a lot of time, distraction, energy and expense.
  4. The entrepreneur and the investor discover, under the pressure of getting the deal done, that they do not work very well together; or one or both of them loses confidence in the integrity of the other. Closing an early stage deal can put a lot of pressure on an entrepreneur (less so an experienced investor, who does a lot more deals). Pressure can bring out the best in a good entrepreneur. And the worst in a bad entrepreneur. Just as bad investors turn off good entrepreneurs, so bad entrepreneurs turn off good investors. Not that you can’t be an aggressive, take no prisoners entrepreneur and succeed, if that’s your style. But whatever your style, wear it well.
  5. Internal events at the investor’s shop derail the process. Say, for example, the partner leading your deal moves to another firm, or gets hit by a bus. Stuff happens, and when it does, deals often die. Being good is not enough in the high impact entrepreneurship world. You’ve got to be lucky too. Or at least not unlucky.
  6. A major external event shocks the market generally or the particular segment of the market the deal is in. Remember 9/11? I do. And so do several entrepreneurs I know who were trying to close deals at the time. More failed than succeeded. I’ve also seen deals blow up based on a shock to a particular market segment, as for example diagnostic deals in the aftermath of a major patent ruling that basically gutted the IP protection upon which the bulk of diagnostics companies were built. The take home lesson here: after you get the term sheet signed, close your deal with all deliberate speed. And stay lucky.

When an entrepreneur tells me they have a lead investor on board, my first reaction is to ask some questions. Who is it? Have they signed a term sheet? How much are they committing? How confident are you that all of your due diligence ducks are lined up? If the answers to these questions are satisfying, I’ll mentally note that the deal in question will most likely happen. Unless it doesn’t.

Stanford Offer is a Good Thing

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Stanford Offer is a Good Thing” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

“So the good folks at Stanford University’s business school want to lend a hand to the ‘underserved’ folks in flyover country.

Good for them — and us.

Even way back when I was in school — we are talking late 70s to mid 80s — the attraction of Stanford was, at least in part, that it was ‘there.’ And I was ‘here.’ A ticket to Stanford was generally thought of as a one-way ticket: ‘Go west, young man,’ Horace Greeley advised; and don’t come back, he implied.

As it turns out, I did not go to Stanford, and instead got my MBA and JD closer to home, in Chicago. But my first post-education stop was in Silicon Valley, and it was a great move that I never regretted.

Montana’s Robust Startup Scene

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Montana’s Robust Startup Scene” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

“Folks at the Kauffman Foundation – one of the more credible of the various organizations that track entrepreneurship activities across America – recently ranked the various states in terms of the strength of their entrepreneurial sectors. As gener8tor’s Joe Kirgues wryly noted, “at least Wisconsin finished in the top 50.” Which is to say, 50th.

I must say I am not a huge fan of these kinds of rankings. Frankly any ranking of this sort that doesn’t have Northern California at the top of the list is more than a little suspect. Still, by chance I happened to be in Missoula Montana last week, working with several startups at Montana Technology Enterprise Center, or MonTEC, the University of Montana’s technology accelerator. That Montana. The Montana that Kauffman put at the top of its list of states ranked by the strength of their entrepreneurial sectors.

In a lot of ways, Montana is a lot like Wisconsin, only more so. It is hard to get to. The climate is challenging. Not a lot of people live there. And there are no big cities (in fact, there are no cities as “big” as Green Bay). There is just one institutional venture capital investor. It’s fair to say, I think, that Montana’s challenges, in terms of building a high impact entrepreneurship sector, are even more formidable than those facing Wisconsin.”

Click here to read more.

Those Who Do it All… Shouldn’t

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Those Who Do it All…Shouldn’t” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

“In more than thirty years in and around the high impact entrepreneur and investing space, I’ve come to the conclusion that every entrepreneur, even and in fact particularly the most successful, has at least one serious personality flaw.

One of the more common flaws is the “I can do it all” personality: the entrepreneur who insists that they are not only good at, but the best at everything involved with making their business a success.

What really makes the “I can do it all” entrepreneur so frustrating is not so much that they are almost always wrong about their capabilities. Rather it is that even if an entrepreneur really is the best at everything actually doing everything is still a bad idea.”

Click here to read more.

The Silver Linings in the Fundraising Cloud

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “The Silver Linings in the Fundraising Cloud” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

“Entrepreneurs generally think of fund raising as a real drag. For all but the sainted few, it is a time-consuming distraction from growing the business. A bothersome exercise courting folks who think they are smarter than you are (and sometimes are). And all too often at a time the cash clock is rapidly ticking down to zero.

But it’s not all bad. Really. As dark as the fund raising cloud is, there are several silver linings (besides closing on the capital) that make the process useful, if not pleasant. Herewith a couple of those silver linings.

Click here to read more.

SEC Issues Proposed Rules to Increase Financial Thresholds Applicable to Smaller Reporting Companies

The U.S. Securities and Exchange Commission (SEC) has proposed rules that would amend the definition of a “smaller reporting company” by significantly increasing the applicable financial thresholds. In an effort to promote capital formation and reduce compliance costs for smaller companies while maintaining important investor protections, the proposal to update the definition would expand the number of companies that qualify as smaller reporting companies, thus qualifying for lower levels of required disclosures in prospectuses and periodic filings (such as requiring disclosures for a reduced number of annual periods and the elimination of the need to include risk factor disclosures and certain financial data).

Smaller reporting companies may provide scaled disclosures under the SEC’s rules and regulations. Currently, smaller reporting companies are generally defined as companies that have less than $75 million worth of company shares that are held by the general public (i.e. public float), or companies that have zero public float and annual revenues less than $50 million.

The proposed rules would revise the definition of smaller reporting company to qualify a company with:

  • less than $250 million of public float, or
  • no public float and less than $100 million in annual revenues.

In addition, as in the current rules, once a company exceeds either of the thresholds, it will not qualify as a smaller reporting company again until public float or revenues decrease below a lower threshold. Under the proposed rules, a company would re-qualify as a smaller reporting company again once its public float is less than $200 million (instead of $50 million under the prior rules) or, if it has no public float, once its annual revenues are less than $80 million (instead of $40 million under the prior rules).

However, we should note that the SEC is not proposing to increase the $75 million threshold in the “accelerated filer” definition. Therefore, companies with public float between $75 million and $250 million may qualify as smaller reporting companies, but still be subject to the requirements that apply currently to accelerated filers, including the timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal controls over reporting required by Section 404(b) of the Sarbanes-Oxley Act of 2002 (unless a company is an “emerging growth company” under the JOBS Act).

Many smaller companies are challenged to meet the excessive reporting and compliance costs that come with being a public company, which the SEC has estimated to be about $2.5 million for initial compliance costs in the case of an IPO and $1.5 million annually for ongoing compliance. The proposed rules, however, would offer substantial compliance and regulatory cost savings to an expanded number of companies (for example by reducing certain financial and executive compensation disclosures in periodic reports and proxy statements).

This may lead to mid-size companies who are currently reluctant to go public to more readily consider that option. However, companies may remain reluctant to go public due to continuing concerns of an increased potential for claims made by investors and related liability.

Public comment on the proposed rules should be received by the SEC no later than 60 days after publication in the Federal Register.

For more information, please contact your Michael Best attorney; Michael H. Altman at mhaltman@michaelbest.com or 414.225.4932; or Daniel J. Gawronski at djgawronski@michaelbest.com or 608.283.0124.

Look Before You Leap

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Look Before You Leap” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

Being a high impact entrepreneur is kind of like being a sports star: everybody wants to be one; almost no one credits how much work is involved.

The time “in the spotlight” is like the shining tip of the iceberg: most of the actual work is below the surface, where the environment is mostly cold and dark.

My object here is not to discourage anyone from making the jump to high impact entrepreneurship: we need as many folks at the top of the funnel as we can get. Rather it is more of a “look before you leap” message.

Click here to read more.