Wednesday, January 12, 2011

What Part of “Term Sheet” Do You Not Understand?

Angel and venture capital investments are repetitive transactions with mostly customary terms.  There are a limited number of important moving parts that need to be negotiated.  Everyone knows what they are.  Everyone likewise knows what the rest of the documents will look like once the main terms have been determined.  So it puzzles me that we all persist in writing and negotiating non-binding term sheets that contain significant amounts of legalese and boilerplate.  A term sheet is useful as a way to memorialize how the main points were hashed out.  It is not binding.  It can’t and shouldn’t nail down the details.  That can be done when the lawyers circulate draft definitive documentation.

So why do we need more than a page (two at most) to lay out the terms of an angel/VC investment in preferred stock?  Brad Feld and Jason attribute term sheet bloat to word processors.  I don’t buy it.  They’re right that the technology makes bloat easier, but that doesn’t excuse it.  I attribute it to bad lawyering and bad lawyer control.

A good lawyer knows that there’s a time and place for “lawyering” a document and that the early, non-binding stage of negotiation isn’t that time and place.  Bad lawyers get lost in lawyering.  They lose track of the functional reasons binding legal documents are drafted the way they are.  They equate legalese with professionalism.  They get nervous if anything they have a hand in, from business correspondence to office memos to term sheets, doesn’t sound like a form mortgage agreement.

Bad lawyers are primarily at fault for this kind of over-lawyering.  But clients deserve part of the blame.  Lawyers serve their clients, not vice versa.  Controlling lawyers is part of the essential skillset of an experienced businessperson.  A big part of lawyer control is to prevent negotiations and disputes from going into “lawyer mode” prematurely and to keep major business decisions, about deals or disputes, from getting caught up in the momentum of lawyering.  A good lawyer welcomes this kind of direction and management and will happily collaborate in it, advising in the background when lawyering in the foreground would be counterproductive.

I’m attaching a sample two-page term sheet.  I don’t think either the investor or the company runs any risks by using this, rather than the customary long form (lawyers, please do not send me lists of the details I’ve left out unless you can tell me about a deal that fell through because they weren’t worked out in the term sheet).  Read it.  Think.  Talk to your lawyer.

Lawyers serve an important function in transactions, but they can also get in the way of efficient deal-making.  Let’s all work together to keep transactional lawyering helpful and productive.