Don’t shop your term sheet

by Chris Dixon 

There are all sorts of protocols in the VC world. Most of them make sense upon further examination, but if you’re a first time entrepreneur, they aren’t obvious, and it’s very easy to mess them up. Here’s one of them.

From VC’s perspective, one of the most annoying things an entrepreneur can do is “shop” a term sheet. That means after they’ve offered you a term sheet in writing you take it to other investors to try to get a better deal. Most VCs I know won’t even send anything in writing until you have verbally agreed on all essential terms precisely to avoid this possibility.

Why are investors so sensitive to this? First of all, no investor wants to think they are “just money” – the idea that you want to get an explicit auction going suggests that.

More importantly, what often happens is that once a VC has offered you a term sheet – especially if that VC is well respected – other VCs suddenly become interested. It is pretty much guaranteed that if Sequoia offered you $4M pre, there are many other investors who, simply because of Sequoia’s offer, would offer you a higher price. So if Sequoia allowed their term sheets to be shopped they’d never get deals done.

Some entrepreneurs think they are being savvy by shopping a term sheet but I would strongly caution against it. The VC/startup community is extremely small and this will usually come back to bite you.

Note that I am not saying an entrepreneur shouldn’t get a competitive process going and try to get the best deal with the highest quality investors. You just need to do it in the right way. Discuss things verbally and only accept a term sheet when you have agreed on all significant terms. At that point, assuming the term sheet agrees with what you said, you should sign it and return it within a day or two. (Don’t say you need to wait for you lawyer to review it – if you want to be an startup CEO you need to learn how to review and evaluate term sheets. Have your lawyer teach you about term sheets before you receive them.).

Also, don’t shop a verbal offer. You can’t go to, say, Greylock and tell them Accel offered you 4 pre. First of all they might collude. Secondly it’s very likely to get back to Accel (they all know each other) and you might lose both deals. What you can say is “I’m planning to wrap things up by X day and I have a lot of interest” and see what Greylock does.