September 9, 2022

What founders need to know about term sheets in a downturn

Before the downturn, they were founder-friendly — what’s changed?


6 min read

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Silicon Valley Bank
Glen Waters, head of early stage practice EMEA at Silicon Valley Bank UK

Over the last decade, term sheets have gotten friendlier for founders — they became shorter and deals have become less structured. But now with more volatility in the market, they may look a bit different. 

In basic terms, a term sheet is a nonbinding agreement that shows the conditions of an investment — kind of like a blueprint. 

“Getting that term sheet is the holy grail. Why it’s so critical is it usually determines the final structure of the investment,” says Glen Waters, head of early-stage practice EMEA at Silicon Valley Bank UK. “There’s a few things founders should keep in mind, particularly as the market changes.”  


For a founder, signing the wrong term sheet can end up costing you hundreds of thousands of pounds, if not millions. So what do founders need to know about term sheets in a downturn? 

The terms 

David Strong, a legal partner at Marriott Harrison, says there are two key areas to a term sheet: the financial side (including what your valuation will be) and the governance side, or how the company is going to be run and who has the right to influence decisions.

For Waters — after valuation — the most important term in a term sheet is around structure and specifically liquidation preference, which he expects will change in the current market.

You might think you own 35% of the business. In reality, this can be really different depending on the preference stack

The liquidation preference refers to what happens to your company when it gets acquired, merges or gets closed down. It places the preferred shareholder at the front of the line when it comes to divvying up the exit proceeds.

“The market standard has been a 1x non-participating preference, where the investor has a choice to get their investment money back ahead of the other shareholders or the investor participating as an ordinary shareholder on a pro-rata basis,” he says. “The alternative is what’s called a participating preference and this is known as the ‘double dip’ — where an investor gets their money back and then gets to participate on a pro-rata basis on the remaining exit proceeds.”  

Waters says founders need to think really carefully about the structure they go with. 

“Look at the exit waterfall. You might think you own 35% of the business,” he says. “In reality, this can be really different depending on the preference stack. As a founder, you need to analyse how much you’ll be getting at various stages with different clauses because sometimes a low valuation with the right structure can lead to better outcomes.”

While Strong says he’s seeing the vast majority still going for a 1x non-participating liquidation preference, some players may try to lean more on a participating preference in the current environment. 

Instead, he suspects we might start seeing an increase in multiples — so investors saying they would need to be paid back more than the full amount of their investment before anyone else participates. 

Different markets, different investors, different trends

For Charlotte Battelott, an investor at MMC Ventures, different term sheet trends depend on where in the market you’re looking. But for her and her peers, their terms haven’t really changed because of the downturn. 

What we’re seeing is people who potentially haven’t been in the ecosystem as long as some others... they’re putting more structure in their term sheets

“What we’re seeing is people who potentially haven’t been in the ecosystem as long as some others,” she says. “I’d say they’re putting more structure in their term sheets, as opposed to what we’re doing and other close peers and competitors of ours.” 


For the most valuable businesses, Battelott says the term sheets will be quite simple. But rescue situations and other areas of the market are experiencing changes. 

“What you do hear in the market and it’s difficult to know in detail, but people do pull out late in the process, that does happen,” she says. “The excuse to the outside might be something’s coming from diligence. It might be that people have got cold feet on the price and over the past few months my hunch would be that it’s probably the latter.” 

'A whirlwind of confusion'

Something that doesn’t change is the confusion term sheets can generate for founders. 

Helen Murphy, the CEO and cofounder of supply chain startup Opply, says term sheets can get very nuanced in the later stages, but in the early stages founders can struggle with just knowing where to give and take.  

Founders certainly should not be waiting long at the term sheet stage to be engaging lawyers

“We were first-time VC founders and it was a whirlwind of confusion about the whole thing,” she says. “It was actually difficult to know what was important and what to look at.”

Murphy says she asked her investors for knowledge on term sheets. Even though they were in a beneficial position, she adds this was key to building up an investor-founder relationship and being honest about what she cared about. 

“That was actually a top three decision-making point for us of which investor we went with in the end. We felt that our lead was the one who really set the time to go through [the term sheet] with us and have quite personal conversations,” she tells Sifted. “If you don’t implicitly trust your investors, don’t sign,” 

Battelott says MMC Ventures always calls founders to walk through their term sheets with them. But another practical resource — and neutral party — are lawyers. 

“They see a lot of what’s going on in the market so it’s a good litmus test to say is this really off the beat, is this in line with expectations given the stage of the company we’re at,” says Battelott. “Founders certainly should not be waiting long at the term sheet stage to be engaging lawyers.” 

Always negotiate 

Strong says he regularly sees first-time founders who are very reluctant to negotiate anything on the term sheet they’ve received. Battelot adds that not negotiating is looked upon negatively by investors and there won’t be much room for changes once you sign. 

It’s a red flag if someone doesn’t negotiate on our term sheet because ultimately I think they haven’t understood it

“To me, it’s a red flag if someone doesn’t negotiate on our term sheet because ultimately I think they haven’t understood it,” she says. “Once the term sheet is signed, the majority of the commercial points should be in there, there shouldn’t really be too much negotiation.” 

Strong adds founders need to be more careful in a downturn to make sure all the terms they need are in the term sheet. 

“Shorter-term sheets for founders were alright last year,” he says. “If there were terms that weren’t in there, the founders probably had a better-negotiating position to win that negotiation. But in the current markets, if the term is not in there the investor is probably likely to dig their heels in a bit more.” 

Waters agrees. “Really work through the term sheet because once you’ve signed it, you’ve set an expectation,” he says. “It makes life a lot easier if you actually do that negotiation up front and makes it cheaper in the long run as well.” 

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