In last month’s post we reviewed the reasons why there can be differences between the conditions set forth in a term sheet and those in the final shareholders’ agreement.
We concluded stating that there are ways to lower the negative impact on your business which can result from major differences between the original term sheet and the final SHA.
One way you can lower this adverse impact is by fundraising at least 6 months in advance. This is a topic which I covered in an earlier post. Having more cash in the bank when you’re fundraising will make you less reliant on your potential investor. This will make it easier for you to walk away from an SHA that is significantly different than the term sheet you agreed to.
A second way to minimize the potential negative shock of the SHA is to negotiate with multiple investors at once. By keeping your options open, you will lower your dependence on any single potential investor. If one or multiple investors produce a negative surprise, or signal that they are likely to do so during the due diligence process, you’ll be able to move forward with the others.
In order to retain a stronger negotiating position, many investors ask for exclusivity which prevents an entrepreneur from talking with other investors during the due diligence period. I’ve seen exclusivity requests range any where from 3 to 6 months. Investors try to justify the need for exclusivity by stating that their team will be dedicating significant time and resources to evaluating the business. Inviting competition to the table would make it less likely that their time and efforts pay off in the form of an investment as the startup may choose to accept another offer.
While this seems like a reasonable request at first glance, flipping the table it’s easy to see that it isn’t a fair demand. While the investor may be dedicating significant time and resources to evaluate the business, the startup is dedicating at least as much time and resources by making its team members and internal data available for the investor’s evaluation. If it’s unfair for an entrepreneur to choose another investor’s offer after an investor has put forth significant effort to understand the entrepreneur’s business, it’s equally unfair for an investor to walk away from the table or significantly change the conditions of an investment after a startup has focused all of its time and resources on one specific investor.
The best solution is to let the free market between entrepreneurs and investors continue to operate during the due diligence phase. In other words, if you’re an early stage startup, don’t grant your potential investors exclusivity.