Reducing friction

The evolution of term sheets in early-stage venture investments

As the venture capital market cooled from the heights of the post-pandemic capital rush, founders’ ability to secure a term sheet has become harder. Once the term sheet does land, founders struggle to reconcile what seemed to be ‘market’ to the terms in front of them. We are seeing a shift towards investors seeking to ‘reset’ the investor / founder relationship.

As consumer demand for second-hand goods continues to grow, we expect that M&A activity in the recommerce sector will only increase.

Approaches to investment terms vary based on the popularity and perceived risk of a sector. Inevitably, key investment terms evolve and are applied in different ways to different businesses. We believe the recent lack of 'franking' of high post-pandemic valuations and fewer exits have led to tougher investor terms. 

Evolving deal terms

The volume of VC investment has decreased, the number of exits has reduced, and deal terms have evolved.

During the last 18 months, the volume of VC investment has decreased, the number of exits has reduced, and deal terms have evolved. We are seeing three key developments:

Leaver provisions

The requirement for cliff and vesting periods for founders is not a new concept, with 3-4 years vesting and 1 year cliff remaining a standard ask at Seed / Series A stage.

​This is increasingly being extended into later rounds and the term sheet can dictate a hard ‘reset’ with a 100% revest. Founders and investors must assess whether a full 'reset/revest' meets both parties' needs, considering the nuanced balance of risk and reward.

The number of exits for European tech businesses has significantly decreased. Investors seek assurance that founders will stay involved, especially as growth and the time from investment to exit may take longer. Founders want to know the work they have committed to date has real value.

​We are seeing more scenarios where vesting is ‘reset’ on later rounds, but not on a 100% basis, with some part of what would otherwise be vested carved-out and treated as fully vested (usually around 25%). Discussing this at the term sheet stage is crucial, as it becomes an emotional and costly issue to address later.

​Anti-dilution waiver

A key downside protection for investors in VC-led fundraises remains anti-dilution protection. Unsurprisingly, an anti-dilution right is often included in a term sheet. What is surprising is the rise in new investors requesting existing investors to fully or partially waive their anti-dilution rights. The main reason for the request is to 'rebase' valuations from the peak levels of 2021 without overly penalising founders. This has a greater impact for down round fundraises, but it can also play out for flat rounds (particularly where there has been bridging financing provided via convertible debt).

The volume of VC investment has decreased, the number of exits has reduced, and deal terms have evolved.

Founders may view an anti-dilution waiver as a 'win,' especially when valuation increases are hard to achieve. But the challenge lies in distinguishing between new and existing investors, and between those who follow on and those who don’t. Founders must carefully manage relationships with existing investors, ensuring any consents or vetoes are addressed early. Founders should have these discussions before circulating a term sheet that might request something from an existing investor that they are unwilling to give. 

​Two common compromises we see are (i) full anti-dilution exercise being coupled with greater option pool expansion (with founder shareholder participation); and (ii) greater ‘pay to play’ requirements where existing investors that are following on are treated differently. 

​ESG policies

It is now common for term sheets to include provisions on implementing specific ESG policies and reporting tailored to the relevant VC. ESG is core to how many founders wish to operate their business, but is often not something they have ever considered to be a ‘policy’ or something to produce a report on.

​VCs are currently working through questions regarding the terms, ESG policies, and reporting formats. As a founder, it is important to ask if the VC has template reports and policy wording (they should if other portfolio companies are providing them). Where possible, agree upfront that a single form of reporting is beneficial to all investors.