Demystifying Venture Capital Term Sheets: Benchmarks, Market Terms, Negotiations
In June, we co-hosted an in-person panel event with Marriott Harrison & HSBC Innovation Banking on Term Sheets, inspired by HSBC Innovation Banking’s Term Sheet Guide! We were joined by a stellar panel including: Maria Wagner (Partner, Beringea), Glen Waters (Head of Early Stage Practice, HSBC Innovation Banking), Peony Li, (Founder & CEO, Jude) and moderator, David Strong (Head of Venture Capital, Marriott Harrison).
Spearheaded by Glen, HSBC Innovation Banking pulled together data from 245 signed term sheets from 2022 to identify key market trends so that founders are better equipped with the industry standard and to help combat the asymmetry of information between founders and investors. Where founders might see only a handful of term sheets in their business lifetime, investors see hundreds. This guide aggregates data from 245 signed term sheets from 2022 to identify key market trends so that founders are better equipped with the industry standard.
It was a lively conversation, given the variety of perspectives and (sometimes) opposing views on how to interpret the guide’s insights. Here we outline the key takeaways from the event and advice our panellists provided to founders:
Expect more scrutiny at Seed
Peony raised her first round in 2021 and second round at the end of 2022 — wildly different climates. Pre-seed rounds often involve less scrutiny over each clause and valuations are set by angels or pre-seed funds. However, seed rounds attract more attention and negotiations around valuations. Peony encourages founders to always ask around and understand the average valuation for deals being closed, taking into consideration your sector, market conditions and your traction.
Negotiate upfront
The more you negotiate upfront, the smoother the deal. Negotiation is never easy but it sets the tone for the partnership going forward. Investors *should* take time to explain each term and their positioning if need be and founders should respond upfront with their thoughts. It saves everyone time and money!
More participating preferences
In the current economic climate, we’re seeing a growing discrepancy between founders and VC’s expectations on valuations. This means term sheets are more structured (versus 2021) with more participating preferences to increase the returns for VCs at a lower-level exit. As Maria notes “This makes less of a difference if you’re exiting at a billion but if you’re exiting at 50 million, investors want to ensure these terms are in place”. If you’re pushing for a valuation that is probably beyond where the business has got to, the investor can only make the deal happen by putting this structure in place and — as it’s often referred to — “double dipping” into the returns.
Calculate how your option pool affects valuation
Industry standard appears around the 5–10% mark for the option pool for future employees. Be sure to factor this into your cap-table calculations as this will dilute previous investors and could impact your post-money valuation. Avoid giving away too many options early on and look ahead to avoid having to negotiate with your investors on injecting more options into the pool. Oftentimes investors prefer that you allocate an option pool at pre-money valuation (i.e. the valuation prior to investment) which means investors will not get diluted. Yet if you allocate an option pool post-money investors will also get diluted alongside the founding team and any existing investors.
Board observers & investor updates
“In pre-seed rounds you might want to have just a board observer unless raising a very large venture round. That will give you more flexibility to operate the business versus needing to spend time managing the board. Investors at this stage just want to see you build the company.” shares Peony from Jude. However, for a seed round, Peony notes that “we all want to have more governance in the company. It’s very good training for a founder to be regularly doing updates and having board meetings, discussing not just the figures but also, the next six months, the next 12 months, where the company is heading”. Peony says it’s good to spend around two days a month on investors’ updates and management.
Negotiating founder terms
Founder vesting and lever provisions are crucial terms and negotiating them upfront is essential. Founder vesting is more common in seed-stage term sheets (64% included in report) but reduces in later stages. The most common vesting period is three or four years, sometimes with a cliff for founders. Leaver provisions, such as good and bad leavers, are present in 55% of overall term sheets or 68% at Seed stage and can be complex to negotiate but should be addressed early.
Instruct a reputable lawyer!
A key takeaway from the event is the importance of appointing experienced VC lawyers. Lawyers can provide valuable guidance and insights into the negotiation process, helping founders and investors to navigate the complexities of the deal. Be proactive in instructing a reputable lawyer who will ensure negotiations are smooth yet effective.
An enormous thank you to Marriott Harrison and the team at HSBC Innovation Banking for co-hosting this event with us and of course to our brilliant panel.
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