One thing that we encounter regularly among early-stage startups with inexperienced entrepreneurs is their inability to identify when advice they see in the market – from highly seasoned, very intelligent but also highly misaligned players – that appears to be in their best interests is in fact a clever sleight-of-hand to trick them into making decisions that others profit from.
One of the clearest examples of this is the suggestion that when you’re negotiating a term sheet, short and simple is the best. The advice you’ll hear from investors is “Focus on keeping it ‘standard’. Keep it simple, and close fast.”
If you’re a first-time entrepreneur taking on tech investment, you’re likely negotiating with people who have, literally, 100x the experience that you do. They know all the ins-and-outs of the documentation, and the subtle ways in which various terms play out over time in terms of high-stakes, permanent economics and control. Given this extreme imbalance of experience, do you really think rushing into it, and not asking appropriate hard questions, is in your best interests? Or is “close fast” perhaps really a strategy that will ensure your investors benefit from your inexperience?
Y Combinator recently published what they call their “Standard and Clean” Series A term sheet that unfortunately seems to follow this path. It is remarkably short, leaving out very material control and economic concepts, under the stated premise that keeping it short and simple will help entrepreneurs “close fast.”
First, a “standard” deal does not exist. Yes, there are various market norms and typical structures, but all of them have very high-stakes exceptions and ranges open for negotiation well within the norms of startup finance. High-volume investors like YC and other funds have strong incentives to influence market standards in ways that benefit them, at the expense of startups, and so the promotion of so-called “standards” is a way to sway the market in their favor; with “saving money” on fees as a pretense. When any investor tells you X or Y is “standard,” talk with experienced advisors without conflicts of interest to assess this so-called “standard.”
Second, when you sign a term sheet that has left out material issues, you are hurting your leverage in negotiation. Once you sign a term sheet, you are almost always locked into that deal with a “no shop” provision, which requires you to cut off talks with any other alternative investors. Secondly, once you go to definitive documentation (after signing the TS), you will start accruing legal fees, which puts pressure on you to close in order to pay those fees.
Don’t sign short term sheets with big gaps, like YC’s. It’s a way to reduce your leverage and punt negotiation to a context where investors are advantaged. We have many YC companies as clients, and we know bay area norms, on top of more national tech market norms. While YC is a great organization with a great reputation, the term sheet they have presented is too short, and not “standard” at all.
For a deeper discussion on the problem with “standards” in startup finance, how they are being manipulated, and a more in-depth guide for negotiating YC’s template term sheet, see: The Problem with “Standard” Term Sheets (including YC’s).