After completing a long process identifying the right venture firms to pitch, running an exhaustive fundraising process, finding a mutual fit, and successfully negotiating terms… at last, the term sheet is signed. So at this point it’s OK to just hand the process over to your lawyers, sit back, and let them work out the details, right? Wrong.
The two- to six- week time between the signing of the term sheet and closing is “venture limbo.” At this point, entrepreneurs know who they’re going to be working with and along what structure, but the deal isn’t done yet… including wiring of the funds! Most of this time-period is taken up by lawyers drafting and then negotiating the finer legalese points of the full set of legal documents. But it also includes legal due diligence, rounding out the round with additional syndicate investors (often angels in seed rounds), figuring out allocations, as well as sometimes even (but hopefully not) additional business diligence for the institutional venture investors.
The problem is that time kills all deals. The longer this limbo period extends, the more risk is introduced that the process will veer off course or even fall apart entirely. It should feel like things are accelerating towards a close, as opposed to marching along at a steady pace; and it certainly should not feel like deceleration towards the end.
The possibility of negative scenarios adversely affecting the outcome range all the way from some uncontrollable exogenous disastrous macro event (of which there have been a few major ones in the last dozen years) to the possibility of a venture firm simply getting cold feet and backing out. Obviously, only the latter is within the locus of control of everyone involved. It doesn’t matter the reason – a competitive funding announcement, a customer loss, a bad month of results – with more time, the increased chances of more emerging mitigating factors to getting the deal completely finalized. And even if the relationship with the VC partner leading the investment seems solid, entrepreneurs have little window into his partnership political dynamics during that time which could force him to lose his hold on pushing the commitment over the line.
What can extend the month of limbo? Lawyers going back and forth on minute/inconsequential details, of course. But frequently, there is time spent negotiating business terms which weren’t specified in the tern sheet itself. Founder vesting is the most common example. Or sometimes VCs renegotiate terms or introduce new concepts – nefarious, but I’ve seen other firms exerting their negotiating leverage in a relationship given this situation. And I’ve seen weird unpredictable situations crop up that delay things, too. As an extreme but real example, once a standard background check which was run on the startup’s CEO reported that someone with his exact name from his exact town was a felon convicted of embezzlement. It turns out it was literally the wrong guy, yet same name / different person, and the entrepreneur was asked to sign an affidavit maintaining it wasn’t him. But the whole cycle delayed the closing and almost derailed things because of the uncertainty.
The good news is that these scenarios don’t happen often. At the end of the day, a VC signs a term sheet for a reason: they’re making an agreement under the circumstances which they’re eager to do. The job of the entrepreneur is to ensure those circumstances don’t change too much in the interim. And most VCs (including all of us at NextView) pride themselves on their reputation about keeping their word, not backing out of term sheets or renegotiating after they’ve been signed. But the takeaway here is that the fundraising process isn’t complete until the money is in the bank.