Terms of engagement: Offering your business’ hand in marriage
At a recent Los Angeles Venture Association (LAVA) panel discussion on term sheets, panelist Emily Yukich likened the entrepreneur-investor agreements to engagement rings. It’s an apt comparison: In both cases, the parties are affirming their belief in their relationship in a nonbinding contract that serves as a starting point for formal vows.
Term sheets typically include agreements on matters such as how much the investor will purchase the business for, whether they will serve on the company’s board, if they will receive dividends, etc. The documents merely clear the way for the parties’ attorneys to draft a binding contract—but that doesn’t mean there’s not a lot to say about them. As much was clear at the panel discussion, which was moderated by Laurelle Johnson, president of Strategies for Growth; participated in by Ms. Yukich, a partner with Fox Rothschild LLP and the chair of the Women in LAVA Interest Group; Sam Jones, the CEO and co-founder of Formation Media; Rosemary Nguyen, the principal and managing director of iCapital Finance; and Peter Cowen, the principal of Peter Cowen & Associates and an early-stage investment banker and strategic consultant.
One point that all of the panelists emphasized was that entrepreneurs need to know whom their investors are. Ask for references from businesses they have invested in or conduct a background check on them. The panelists suggested entrepreneurs think of term sheet discussions as a sort of courtship dance: How the investors perform foretells how they’ll perform as partners. Even with the right terms, the panelists stressed, bad investors make for a bad deal.
Once an entrepreneur has decided to partner with an investor, they have to decide exactly what they want the investor’s role to be. Most entrepreneurs prefer that their investors be involved only financially (as opposed to, say, working at the company). Ms. Yukich recommended that entrepreneurs “manage” their investors by communicating with them regularly including sending them company financials at regular intervals.
The panelists also discussed how much entrepreneurs should ask for, for their business. Of course, Mr. Cowen pointed out that this depends on how badly an entrepreneur needs money. But, putting that aside, he and Ms. Nguyen agreed that the value of a business is based on the entrepreneur, their experiences, the milestones the business has reached and how strongly the investor believes the business will reach the milestones the entrepreneur says it will. It is also related to economic conditions. Deals are being valued at greater amounts now than they were a few years ago. Ultimately, the panelists said, business valuation is an art, not a science.
Entrepreneurs typically need enough money to reach some particular milestone, plus funds for a buffer. The amount of money needed depends on how capital-intensive the business is and how long it will take to become cash-positive. Professional investors generally need to own 20 percent to 40 percent of the business.
In talking about what a term sheets’ actual terms should be, the panelists reiterated that the agreement is supposed to be a framework: It should establish the most important points and set the parameters, but stay flexible. That’s not to say term sheets shouldn’t be detailed, Ms. Yukich said. They should be—and they should be reinforced by the counsel of competent attorneys.
Ms. Yukich advised entrepreneurs to go into the term sheet process knowing themselves and what they want from their business. For example, she said, women oftentimes want to retain more control over their business than men do because one of the reasons they started a business was to have control over it. Entrepreneurs should ask themselves what’s most important to them: Control? Growth? Just making a living? The answers should inform what terms they seek.
The “I Do”
When terms have been agreed upon and decision-time has come, the panelists encouraged entrepreneurs to try to separate the unavoidable, highly emotional component of the term sheet process from their decision-making, but to listen to their truest instincts. It’s also wise for entrepreneurs to consult their trustworthy advisors: attorneys, accountants, management, etc. These people will give them the best advice on strategy, growth and their goals. Finally, if an entrepreneur decides not to proceed with a term sheet (and they do have that prerogative), the panelists recommended that they be gracious to the investor.
-By Berbay Principal Sharon Berman