Busted Term Sheets

Posted on by Andrew Parker

A busted term sheet is an emotional gut-punch. 

You’ve spent the last 3 months of your life getting organized around fundraising. You built a comprehensive data room. You did dozens of coffee conversations, leading to a bunch of first meetings, followed by deep due diligence with a handful of folks. You opened up your customers, exec team, and closest contacts to reference checks. You did your research and found the ideal fit VC. You negotiated (ideally multiple) termsheets. And when you signed the termsheet, you, your Board, and the team breathed a sigh of relief knowing that you’re basically done with fundraising for the next 18 months and can go back to building your business. 

And then, the deal falls through (!!)… Time starts to dilate as you rapidly think of the consequences. Am I going to run out of money? Can I go back to that other firm I almost chose instead? Do I have to start the process all over? Do I have any recourse? What will my team, customers, and investors think?

Two of the *best* performing companies I have worked with (one a decade+ ago and one within the last 4 years) both had busted Series A term sheets. I almost feel bad for the VCs that abandoned these deals… they missed out on incredible growth opportunities for ultimately myopic reasons. In general the reasons a term sheet might bust vary:

  • Sometimes a term sheet falls apart because of the macro environment. I saw a lot of companies left at the altar in the aftermath of the GFC in late ‘08 and during the pandemic in ‘20. 
  • Other times it’s an issue endemic to the company. Maybe the company just got sued by a much larger competitor or a patent troll. Maybe the company had a big quarterly financial miss. Maybe the team had infighting and fractured in the 30 days before the term sheet closed. Maybe there’s a PR disaster at the exact wrong time.
  • And, sometimes it’s an issue with the VC. That new fund they said was in the bag turned out to be less certain than they thought. Or the sponsor leading the deal lost internal support suddenly. I once saw a VC sign a term sheet, only to then leave the firm before the deal closed, which of course killed the deal.

OK, your term sheet just fell apart. What do you do next? Start with notifying your Board and any senior execs that met with the VCs. Clear, transparent, and immediate communication is essential in tough times. After that is done, well, it depends on the situation. I’ll spare you a full flowchart, however consider the following:

  • Do you have less than 5 months of runway? If so, try asking the existing investors in the business for some financial support to ensure you don’t have to accept desperate alternatives from a position of weakness. For example, a strong internal investor syndicate might support a *good* company by providing a convertible note or SAFE with the following terms:
    • An amount of capital to provide 3-6 months of additional runway.
    • Don’t try to put a price on this investment at this time because it will affect the prices of any future term sheets. A priced debt note or SAFE will act as a ceiling on near-term term sheets.
    • Instead, provide the capital on an uncapped convertible basis with time-staged conversions.
    • If the investment converts in 0-3 months, it could do so at a 0-15% discount to the next round. 
    • If the investment is outstanding longer than 3 months, investors should be compensated for this risk by either converting into the last round price or by applying a more significant discount into the next round.
    • (NOTE: Not all companies are otherwise doing well! so, not all companies merit this approach)
  • Did you receive other term sheets at the offer stage that you turned down? If so, GREAT. Go back to these investors with candor about the situation. I’d err on the side of sharing more, not less. For example, share the terms of the deal you accepted. Share the full tick-tock story of how and why the term sheet broke. The more you share, the more you will engender trust with your 2nd or 3rd choice offer and hopefully that trust will help them want to honor their prior offer.
  • Do you have outstanding venture debt? This is where your VCs’ relationship with your bankers will matter. Approach your banker with full transparency about the situation. Try to extend the interest-only period of the loan. If your debt has covenants, you might be at-risk of tripping those covenants. While that sounds scary, it’s also very common, and good banks know how to handle these situations fairly (and bad, mercenary banks will show their true colors here). They will never waive or change covenants, but they will allow you to continue to operate with a tripped covenant as long as you maintain solid communication and make progress on remediating the issue.
  • If you have no other offers and sufficient capital to continue without doing an equity round now, it might be worth simply returning to the business without your new round. The gross profit you generate in the coming months can be your non-dilutive source of capital to continue to invest in the business. Go heads down and hit a new milestone with your existing capital. Then consider restarting your fundraising process from a position of strength and reset conversations in 6-9 months.
  • Last, but most important: self care. As a founder you are the emotional engine for your business. If you’re feeling down and beat-up, it will show up in your team, sales conversations, product execution, and recruiting. Take time off if possible once the initial storm clouds start to dissipate and do the things for yourself to rechange, so you can return to the business with full enthusiasm.

That’s the general playbook. Obviously your situation will vary. I’m happy to be a sounding board to any founders dealing with this situation, assuming that Spero Ventures is not a fit for the investment round in question. Feel free to slide into my DMs.