The term sheet and negotiating with investors

Investments in early-stage ventures are characterized by being private and by their ‘equity nature’, as discussed in the previous chapters, stressing the mutual dependence between investor and entrepreneur. Moreover, the investment is typically temporary and done between so-called ‘perfect strangers’ – that is, both parties have large information asymmetry and are faced with agency challenges yet will be condemned to one another because of the illiquid nature of the investment. Compare it to getting married to someone you have just met while being certain that you will separate after a few years, so surely needing a proper prenup. For the time that you will be together, you want to delineate mutual expectations, pertaining to both day-to-day and medium-term behaviour, from both the investor’s and entrepreneur’s point of view. While the end goal of the investor and the shareholders of the company are the same– the creation of value – expectations as to how and when this is achieved might differ. Also, circumstances may change and require an upfront agreement on how to deal with these circumstances so as to prevent conflicts on, for example, the duration of investor involvement, the strategies used to raise company value, financial and industrial alliances, and new opportunities that modify the pre-investment situation. Both investor and entrepreneur will try to solve all potential disagreements before formally partnering; however, it is impossible to forecast the future and make arrangements for every eventuality.