The Dreaded Pulled Term Sheet

-- by Jessie Gabriel 

We’ve all been hearing horror stories of investors dropping out after committing to a raise. You go through all the diligence, they say they’re committing, you may even sign a term sheet, you celebrate with your team–we did it! Then comes the call (or email, or sometimes text, seriously). So sorry, it’s not going to happen. *&%*(&#(&$!. Here’s what you can do to lower the chances of that happening to you. 

I want to start this off with a caveat. This is not meant to be a telling off of startups, investors, or LPs. Admittedly there are some that I would like to tell off (none of our clients, of course), but I’m not doing that here. This is about having a productive discussion about what is most likely to lead to a pulled investment and, thus, what is most likely to reduce the risk of that happening to your business or fund. This is not a 100% risk reduction strategy. Some things will still be entirely beyond your control. So let’s focus on the things you can control. 

Time is of the essence. Often the most damaging thing about a commitment that goes south is the time spent. If you’re raising a startup round (or searching for an anchor for your fund), you may have invested months and months negotiating with this particular investor. While that was going on, you likely stopped raising from other investors (if you have a term sheet, you often have to stop raising). By the time the investor comes back to you, you may be financially f*cked. The twelve months of runway you honestly advertised in your deck is now down to three months and you’ve let all your potential lead investors go. 

What can you do? Keep raising until that term sheet is signed. Up until the point when you sign and thereby grant exclusivity rights to that investor, keep that fundraising energy going. Assuming the investor does require exclusivity, keep that period reasonably brief. You need enough time to get the documentation for the round done, but that’s it.   

For the sake of full disclosure. Some investors will tell you that the only reason they will ever pull a term sheet or written commitment is a surprise in the diligence process. If you have something to hide, we can’t help you. You need to be forthright and honest with your investors. This is not just the law (securities fraud is no joke), it is also good business. This is a trust relationship and you don’t want to give your investors any reason not to trust you. Be honest. If there are issues, be upfront about them. Experienced investors know that no company is without its quirks and imperfections. What they don’t want is to be surprised or to learn about problems from someone other than the founder/GP. If you think a particular piece of information might concern an investor, talk to them about it and do it early. If it's dealbreaker for them, best to learn that before you get to a term sheet. Most investors will tell you that working with a startup or GP that is entirely transparent (rather than trying to put a shiny coating on everything) is a welcome breath of fresh air and makes them more likely to invest. 

Investors aren’t made of money. They may be writing checks, but those checks come out of an account that first has to be funded. If you’re raising from a fund of funds, have they raised their own fund? If you’re raising from a first-time VC, are they being upfront about their own fundraising status? If you’re raising from angels, are they investing right now or is there anything hanging out there that might impact the timing of when they can invest? It doesn’t matter how much someone loves what you’re doing if they don’t have the financial capacity (for whatever reason) to invest. It’s your job to ask those questions and it’s their job to give you honest answers. 

If it happens, take it with a grain of salt. One of the most painful things about this process can be the “reasons” you get when someone does back out. In a reverse of the traditional dating excuses, it’s pretty much always you (not them). It’s always something you’re doing wrong. Fine. Listen to what they have to say and then decide for yourself what is true and what is not. You know your business, you know your gut and you know the value of what you’ve created. Sometimes this feedback is fair and valuable and sometimes it’s not. Be open to an honest critique, then make your own decision. 

Losing an investor sucks. It really sucks. And it’s become increasingly common in the last year. At the same time, losing an investor does not have to be the end. Take inspiration from the great Obi-Wan Kenobi: “If you strike me down, I shall become more powerful than you can possibly imagine.” Watch out.