The lucky few will eventually get to the point where investors seem ready to put money into the business. At this stage investors will normally prepare a term sheet (or “heads of terms”) which summarises the proposed deal and sets out the key points that will be covered in the full contracts later. If you’ve not seen one before, this can be a very scary document, and much of it is likely to be non-negotiable. It is really important to understand what this document means, as it will almost certainly mean the founders losing control over the business. This isn’t about percentage ownership – investors will want vetoes on most important board decisions, which gives them effective control.
At this stage things will run a lot more smoothly with the help of good professional advisors – principally lawyers – who are familiar with the process and the documents involved. If at all possible it is worth pushing for the deal to use the LINC standard documents as a starting point as this will help to keep legal costs down for both sides and they are generally quite fair. Even if the deal doesn’t use the LINC documents, it is worth familiarising yourself with what is in them, and comparing the terms you are offered. This may help in understanding where there is room to negotiate.
The main part of the term sheet that most people will try negotiate is the valuation (what percentage of the business the investors end up owning). Valuation as a subject is beyond the scope of this series (although it is a topic that I plan on writing about soon). Suffice to say that some investors will never move from their original offer, and others will move a little. If a disagreement over valuation is substantial, it can substantially damage the relationship and mutual respect established during courtship.
Once a term sheet is signed the investors will carry out due diligence, usually through their lawyers and technical experts. I have already linked other people’s posts on Due Diligence and recommend these once again.
While the due diligence is completed, there will also be negotiations over the other necessary documents, usually the Articles of Association for the company, and the Investment Agreement (sometimes known as a Shareholders Agreement). These will define the nature of the relationship between the parties after the deal is closed, and where the power lies.
From an agreement in principle to invest (which itself may be the work of months of work), it will take at least a few weeks, and normally 6-12 weeks to actually get the money into the business.