What to look for in a term sheet as a first-time founder

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Securing funding is a stressful endeavor, but it doesn’t have to be. We recently sat down with three VCs to figure out the best way to go about spinning up an investing network from scratch and negotiating the first term sheet.

Earlier this week, we featured the first part of that conversation with James Norman of Black Operator Ventures, Mandela Schumacher-Hodge Dixon of AllRaise and Kevin Liu of both Techstars and Uncharted Ventures.

In part two, the investors cover more specifics about what to ask for in a term sheet and red flags you should look out for.

(Editor’s note: This interview has been edited lightly for length and clarity.)

Why should you know what’s going to be in a term sheet before you see it?

Mandela Schumacher-Hodge Dixon: Do not wait until you get a term sheet to start going back and forth. The term sheet should be a reflection of what was already verbally agreed upon, including the valuation. Don’t wait until you get that legal agreement in your inbox to begin pushing back, because it’s really annoying, and it starts to affect how they feel about you.

I’ve even seen investors pull the term sheet. No one is bulletproof, but you really want to be as bulletproof as possible in every stage of this. That requires preparation and clear communication.

James Norman: As you plan out your whole fundraising process, lean into it and start to see what the market is thinking, you want to have a bottom line in terms of what you’re willing to accept. At some point, you may need to capitulate, but be convinced about [that bottom line] and have a reasoning for it.

VCs are trying to invest in leaders, so they know there’s going to be a power dynamic here. How you manage that and move things forward [impacts] how they think you’re going to do other things like hire employees and land customers.

Which mechanism is best to use at the outset?

Norman: Once you get the term sheet, the game has really begun.

Regarding terms, you want to make sure that you’re getting an agreement that is at parity with the level you’re at with your company. You don’t want to end up with an angel investor trying to give you some Series A Preferred docs or anything of that nature.

If you have a pre-seed or seed-stage startup, 99% of time, you should be using a SAFE (a Simple Agreement for Future Equity agreement that Y Combinator devised in 2013). It’s got all the standard language that you need; no one can argue with it. [If they do], be like, “Go talk to Y Combinator about that.”

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