Term Sheet Manners
Although the title of this post is "Term Sheet Manners", what I am going to write about can be applied to all legal documents, not just term sheets.
The past couple days, I've been going back and forth with one of our lawyers on a deal we are working on. We've decided to suggest some changes to the deal and the lawyers are marking up the documents to show the changes.
We could simply send the marked up document back and say "these are the changes we are looking for". I've taken that approach in the past and it's not ideal. Usually, the recipient gets ticked off and you end up spending a lot of time and energy getting things back on track.
The better approach is to compile a list of the big changes you are looking for and call the recipient and walk them through the things you need changed. It's even better if you can do that face to face, although I wouldn't suggest getting on a plane to do this unless the deal is super important and very material to your company.
There are three primary reasons I've learned (the hard way) that a live discussion is the best way to suggest changes to a deal:
1) It shows respect for the other side. Instructing a lawyer to mark up a document and send it back is a slap in the face and most people get very upset by it if the changes are material.
2) Discussing deal terms principal to principal is so much easier than working through lawyers. I've gotten way more done this way.
3) Many times, there is a misunderstanding of the deal terms being discussed that documents and lawyers can't break through. A conversation can usually resolve these kinds of misunderstandings quickly.
So I suggest that we should all resist the temptation to convey material changes via the exchange of markups. At best, it saves you a twenty minute conversation, at worst it can easily cost you a deal.
Spot on. There’s a world of difference between words spoken in person w/handshake (high touch, warm, encouraging mutual trust) and words wielded like weapons on a paper by lawyers (black and white, icy, suspicious at times) when it comes to deals.I love the fact that we close deals “by hand” with signatures and witnesses, testifying that these people “put their hand” to these documents and were in agreement, in the flesh, at one point in time. [Think wonderful signatures (J. Hancock for example) on Declaration of Independence. ]
I’ve signed just a few deals in my young business life, but already realized that discussing terms face to face is indeed the best option not only because of the three primary reasons that you’ve mentioned but also because saves your time and makes everyone feels safer about the deal. Work on terms changes via email and phone calls has proven to me to be a real pain that can last many more days than it’s really needed.
It’s also important for many VCs to remember that oftentimes they’re significantly more experienced with the nuances of contract and investment terminology than their counterparts, the passionate (and often young and inexperienced) entrepreneurs. So, I think it conveys a sense of mentorship and respect if you can tell them why you’re wanting to make a change, and how it can both be positive and negative for them. Over time, this transparency will make discussions easier in the future. I’ve now been through all of two rounds, and I have friends bringing their term sheets to me, and it’s amazing that I’m the experienced one now — and I’ve seen many times already how little changes (that are not explained) tick them off, because they read a lot into them. Usually the advice I give is to talk with your attorney, consider your options, and get clarification, so I think your advice is spot on.You mention that face-to-face is best; I’d argue that a well-mannered reply via e-mail, with a follow-on discussion would probably be better, as that gives the less-experienced entrepreneur some time to digest the suggestions, and get advice from others, so that they can rationally suggest alternatives — otherwise, they’ll be pretty much in the info-recipient role during your discussion, and then you’ll need follow-on discussions to hash out anything that causes them concern during that first meeting.
I definitely agree with you on your first paragraph. Regarding face-to-face versus email, I have seen both work. If the conversation is face-to-face or over the phone, it needs to be clear that it is just an information dump where the VC can explain the thought behind the changes. The entrepreneur shouldn’t respond until they have digested the information and talked to their lawyer. As long as a real-time discussion is no-pressure I think it can be good as well.
i agree Jake. i am not suggesting that the recipient react during these discussions. they should just listen and hear the reasons, then talk them over with their board, lawyer, etc
I always find tone is important when doing a deal, and redline turns never give tone a chance. Good post.
yeah, Jason, tone is everything in so much of life and business. great word. i am going to use it more around my home and my office.
I think redlines often convey a tone. A nasty markup that shows up around 4:59pm on a Friday afternoon, two or three days after it was promised, with new business concepts presented for the first time makes a statement, no?
I gather you’ve seen that move a few times jay
Great post. I am a lawyer and a number of times I have told clients that it would be more effective to discuss the material terms with the other side rather than trying to run changes that have not been discussed through lawyers. It is not effective from a business standpoint and runs up the legal bill unnecessarily if the point is rejected. For whatever reason, some clients like to do things this way, but it can create ill-will in the deal process.
Another great post Fred. I’m in contract negotiations right now with a number of clients and I find that reining in the lawyers and having a real discussion about why I’m asking for something and accepting my customer’s valid points really sets a positive tone. A legal document is a worst-case scenario but it helps to couch it in a friendly and open way as we start a relationship.
i should point out that the lawyer in this situation was strongly urging me to talk these changes over. i am not sure that most lawyers would prefer to communicate the changes. this mistake is often made by the principal, not the counsel.
Agreed. Particularly at the term sheet stage, the lawyer should only be the front person by default, and even then, for very limited purposes. When I’m representing an entrepreneur in a VC financing, my involvement at the term sheet stage should be to sit down with the client (better than email or conference calls), make sure he/she understands the significant financial terms and point out where I see some deviations from market practice or other problems. Often, I’ll put together a list of bullet points for the client to consider and perhaps discuss with the VC. Sometimes the entrepreneur is comfortable discussing these points directly with the VC, but frequently I’ll be asked to take the lead. That’s a bad habit to get into. There are certainly instances when it is appropriate for me to be the front person, such as dealing with arcane liquidation preference provisions or terms with legal consequences. There is a natural tendency, however, when one lawyer is put out in front, for the other lawyer to get more engaged, and yada yada yada.There is a role for lawyers to play at the term sheet stage of a deal, but generally not as the leaders. The term sheet is an important relationship-building opportunity for the principals, and having the lawyers in charge can impede (or poison) that process.
I agree with that (as a lawyer acting on VC deals, mainly for the company).At the series A stage it is important for an entrepreneur to show that s/he has the ability to negotiate directly with the investors and hiding behind a lawyer is a bad strategy.IMHO, at the termsheet stage, ideally a lawyer shouldn’t have to do much more than a high level review and have a chat with the client to ensure the client knows what is being agreed (for first time investee companies, there is always a learning curve) and I fully agree with Fred that it is a really bad idea to communicate any changes via a markup by the lawyer. The markup should always follow a conversation around the material issues.I think the reason the conversation is sometimes avoided is a lack of confidence by the client in his/her ability to stand behind or explain the changes – surely an indication of weakness.
I love the yada, yada, yada part
I prefer direct and immediate communication, unless one of the parties is already ticked off. Then give it a few (but not too long) and make contact offering a branch of peace. My thoughts on keeping in touch: http://bit.ly/FgjFR
I would add (as an expansion to 3) that when reading changes to a term sheet, especially entrepreneurs reading terms they (we) don’t know very well, they (we) interpret them in the most negative light. When the reasoning and intent behind a term change is explained up front, their is less risk that the other party will misinterpret. Now, they may not like it, but at least they understand where the other party is coming from. Otherwise, an entrepreneur could just embrace the negative stereotype of VCs and look at every change in the worst way (which is not necessarily fair or the real intent). I have been an observer on both sides of a term sheet negotiation and it’s extremely important to over communicate if you want to successfully build a trusting foundation for the (important) relationship.
there may be a broader point here Jake. it may be that we all look at unexpected changes initially in the most negative light
I bet you are right, when I think back on my own experiences this rings true. But I still think there are a couple things about term sheet negotiation that amplify this effect. First, trust is not yet established (at least in the first round of financing, both parties are still new to each other). If I trust someone I am less likely to look at unexpected change in a negative light. Second, information asymmetry gives power to the side that is changing the terms. Most entrepreneurs (I think Dave Schappell described it well) don’t understand all the legalese of term sheets. I bet when one party has a power and information advantage the other party is more likely to look at changes negatively.If we all anticipated a negative reaction to unexpected change and over communicated or avoided unexpected change, the world would probably be a better place.
Yupp that’s what obama was saying in cairo last week
Fred, I think your advice makes sense for you (or VCs that do many deals) but I don’t think it’s a one-size-fits-all recommendation for everyone. For example, I don’t think it works so well for entrepreneurs who have seen only a handful of term sheets before, if any. I wrote a post a while about that touched on this topic. Often for entrepreneurs, it’s better for them to negotiate asynchronously so they have a chance to get counsel from others.
I read Fred’s points as about communication, not negotiation. If you are working with folks that you expect to have a relationship with as investors or board members, you don’t want your only discussion of key business terms to be filtered through lawyers. If one side is going to mark up a term sheet, I am with Fred that it is critical to explain that directly to the other party. That doesn’t mean that you have to negotiate then and there – you can use your lawyers for that – but communicating it directly lets the other party understand why you are doing it and it much better at helping build a working relationship for the future.
that’s right dave and fnazeeri. i’m not suggesting the negotiation should happen during the conversation. the conversation should just be about communication.
I have a lot of experience with this kind of process in a variety of settings. Number 3) happens way more often than it should. Lawyers have to be very precise with their language, which means using more language, which means it takes more time to and focused concentration to bring the complete agreement into picture. Talking through a document the way you suggest works time and again in identifying problems because it puts people on the same side of the table — what’s still unclear? how can we make an improvement. Excellent post
Another cost of communicating changes in deal terms through lawyers is of course the lawyers themselves. At $400+ an hour, it rarely makes sense to have your lawyers communicate a material change because all that will happen is the other side’s lawyer, also charging $400 an hour will reject the change. This goes back and forth a few times and through a couple of conference calls with one side pointing to the term sheet as giving them the moral high ground and the other side making up any number of reasons that the change makes sense in the context of the deal. 3 days later and 10 hours, i.e. $4000 in legal fees later, the lawyers will call their respective principals and ask them to hammer out the dispute anyway. Much better off to circumvent the whole middle stage….
yup. and this is why caps on deal fees will get the lawyers focused on the best way to do this too.
I love this post. It’s really helpful. It reminds me of a friend’s mother, an English teacher, who when asked to review her kids’ papers, would never mark them up; she would just ask them questions. This method served to make them figure out themselves how to clarify the murky parts, and of course become better writers at the same time.
that’s how we approach all of our kids’ homework. it is a slippery slope and the next thing you know, you are doing the kid’s work for them.
Also to be considered: kids learn by observing first, hopefully followed by doing second. You need to let them watch you do it, perhaps several times. They observe and absorb what they need: better if it’s from a pro first.We’ve killed the notion of apprenticeship in this country, but seeing how it’s done right first is still fundamental to learning to do it right yourself later.Lawyered markup is like procedural programming that tells you exactly what to do, negotiating on intent at a higher level of abstraction first is like declarative programming that gives you the logic but not the control flow. So in that sense, lawyered markup is like premature optimization: refines language but loses communication.
I learned VC via an apprentice model. I’m a big fan
We’ve moved away from apprenticeship on a lower level. It isn’t cheap to be an apprentice.The man hours put in by both people involved are very expensive. I wish there were more apprentice programs in the United States for lots of things.
Fred are you available to teach a VC apprenticeship in paying it forward, I like to think as more like doing articles, I sure could use a leg-up without getting dumped.
I’m trying to do just that with a couple team members in our firm
A few points.1) totally agree that apprenticeship is so crucial in any field. I’m grateful to my managers that kindly but firmly re-directed me during my years in corporate America.2) Perhaps only with the exception of where one’s life is in danger, face to face is always better. Body language is so crucial and sadly, missed so frequently in our electronic world. Barring face to face, Skype or video conferencing serves as a nice stop gap solution (you know, when it’s functioning 🙂 )3) I try to avoid writing anything negative down until absolutely necessary. It’s just too easy for the other party to read, reread, and get angrier about the negative aspects. Since this isn’t really avoidable in many situations, I’ve found it helpful to bridge some understanding before writing, then at least it’s a review of what’s been said (and more likely within the proper context / tone).
Great post! When I previously worked in real estate investing, it took me a couple of gaffes before I learned this principle. Some people would take offense to my initial offers (that seemed so clear and flexible on paper). At first I tried to explain that “this is how the game works”, then I realized that there is no “game” and it was really my responsibility to walk the sellers through what can be an often intimidating process. Usually by taking the time to explain things and work with them I was able to get even better deals than I had previously detailed on my inefficient document-only approach.
the best lesson in deal negotiations i ever got was from a real estate lawyer who i had to negotiate a venture deal with back in the early 90s. he asked me about something, maybe it was anti-dilution, and i said “because we always get that provision” he jumped down my throat so fast, and said “don’t ever use those words with me again. if you can’t explain why you need the provision, then i am not going to agree to it”.what a great lesson. his name was morty zeidman. he taught me a lot.
Fred, that’s an *awesome* point. I love Morty! Worthy of a blog post.
Your wish is my command
If you want, I can ghost-write it for you. I learned a lot of lessons from Morty myself.
More Morty, Jay. I can picture him in my head.
blogged about morty this morning – http://www.avc.com/a_vc/200…
Fred, I think your post could be called “Never Underestimate the Value of the Human Touch”. Sound advice – I’ve also learned the hard way.Larry
this is a lesson that i’ve had to learn a few times. i’ve made it as recently as last year.
Very good post. However, I think that these same principles can be applied to more than just term sheets & legal work. Everything from website design to business plan development to project collaboration can benefit from face to face interaction. In working on a website & business plan for a new small biz, I’ve found we get 100% more done when we meet face to face to discuss the design and concept rather than via email. Everyone feels better about the decisions being made and tone, which plays a big role in discussion, is more easily conveyed.First hand knowledge: After a lengthy email chain recently, the end result was my partner thought we were having an argument and I thought we were joking around & having a discussion. Neither of us could convey the proper tone, and nothing got straightened out until we discussed it on the phone.As a side note, your website looks great on the iPhone. However, the Disqus login doesn’t translate well. Had to come back to the Mac to post this comment.
That’s a big priority for disqus. Not just iphone but all mobile web browsers
Forget about costing you the deal…not doing what you suggest costs tens of thousands of dollars in legal fees from both sides’ lawyers pissing on each other!
Absolutely agree. The days when two layers went back and forth crossing each other’s stuff, trying to sneak changes in are gone.
To add to the list:4) First time founders are always afraid of legal documents, so talking on phone and explaining you are not trying screw them and just want to some small protection helps
I find lawyers, though to be honest I haven’t had much dealings with them, to be a wonderful context challenge. I feel that the best thing is to have a lawyer who is wonderfully sensitive to what she is doing and what I expect her to do. Otherwise there seems to be an inherent contradiction between my objectives and the legal process. I am out to do something and the legal process is out to prevent everything else from possibly happening – it is a creative force meeting a destructive force. I do not intend to pass judgment on the legal process – just to see it for how it tends to manifest.In two recent projects I’ve had an opportunity to ponder the nature of agreements without legal counsel available to me. I realized that it would be useful & supportive to have in an agreement an opening part about intents – a reminder to anyone who reads the agreement – of what it is that the parties intend to achieve and what the agreement is intended to support. I felt great with both results because felt passionate (instead of reluctant) about introducing it to people – because it is no longer a defensive/offensive document – rather it is a tool for collaboration.Both examples are available online if you wish to have a look: – an online software application license agreement: http://en.myfem.org/?page_id=5 – an artist agreement : http://sweetclarity.com/sig…Another great side-effect to this may, over time, be that intents can change (expand, collapse, refine, etc.) – and in doing so they may also force me to re-evaluate agreements – and the relationships they represent. In other words – they are breathing life into what is often a rigid piece in a fluid game.I have no experience in investment deals and I realize that this may sound far-fetched “how can an investment deal change?” – but I have a feeling that a question that can lead to some surprising insight is “how can investment deal not change?”.Intents go a long way… if I let them.
Good post. As a result of the process, the comments are even better.Expanding from some of the comments: The problem often arises when the client is uncomfortable having to face up to his counterpart. Perhaps because he’s not so comfortable negotiating generally, or uncomfortable to be asking for the change (and/or can’t explain why he needs it) or there are tensions between the principals. In some of those situations, a brief conversation with your own lawyer to review the script may help you have the appropriate conversation with the other side.In any case, redlined documents are rarely good vehicles to communicate “business” changes.
I would like to add one note on a tool that has been extremely helpful to me in any negotiation and especially when there are real term differences. When I left investment banking in the late 90s and moved to corporate development for a public company my supervisor brought me into a deal that was in process.He had received the initial terms for an asset purchase from the other side and he immediately broke down every term into a table with 3 columns – Description, Their Wants, Our Wants. The value of that simple exercise stays with me today.By listing out the key terms in this way, we broke down the deal into its components and could discuss specific items, not devolve into some rambling discussion. The table showed that we actually had many things in complete agreement and simply 2 or 3 that needed discussion…but we could talk about them in concrete, specific terms.I continue to use the table today and have received compliments on it because it takes emotion out of the game. It does take a little up front work but I find that helps my own thinking as well.Thank you for all you do Fred.Cheers-Paul E. Wright
If you want, I can ghost-write it for you. I learned a lot of lessons from Morty myself.
Very good points. What I usually do is call the counterpart and tell them I’m about to send the contract, and talk them through the most significant changes by phone. I would add that lawyers should be encouraged to mark any change in the term sheet with comments indicating why the chnage has been done: too often one receives a document full of edits, without any indication of the reasons behind them.Working in Asia, there’s the added twist of the language barrier: often you need to have the contract/term sheet translated, and it’s always better to present to the partner in person, if possible, because there are cultural issues as well to consider: Asian cultures in general rely much less on the written word for contracts, and people are often put off by overcomplicated ones. To establish trust between the parties, it’s useful to state over again where everyone’s coming from, and if possible to demonstrate flexibility. In any case, a contract in Asia is not, as in the West, the arrival point of a negotiation: rather, it’s a snapshot of the current situation, that can and will evolve as conditions change.
Wow. Doing business in asia seems hard
And fun 🙂 Basically, doing business in Asia has all the elements of doing business as in the West, with a superstructure of culture, bureaucracy, legislation and personal relationships to take into account. I always say that, coming from Italy and having worked in Latin America for a while, it’s much easier for me to adapt than for someone coming, say, from Germany or US, countries with business cultures based on the essence of business itself, rather than on the superstructure built around it.
For sure. You’ve got a great background for it
That is surely a refreshing take on how to approach a term sheet Fred. I hope some of the VC’s here in the UK read your blog. You wouldn’t like to open a London office would you ?The ability to discuss the deal terms principal to principal sets the tone for the whole relationship going forward.
lost a deal 10 years ago as a result of exactly what you’re describing here Fred and i’ve gone the voice route ever since (the lessons you learn as a vc are painful and stay with you forever). good advice pal…
I agree with this approach. We all need to remember that lawyers (on both sides) are there to protect their clients. The best ones will advise on the business elements and help make the deal happen. But most, will just stick to the legals and client protection. All material business points should be delt with directly between the investor and management.
“American does business with its friends.”The first requirement is therefore to make friends.Any deal negotiation is a dialogue in which perhaps competing objectives must be massaged and compromised to obtain a mutually agreeable result. Very few dealsmiths take the time to ask the other party — what exactly are you looking for and what exactly are you expecting to happen?I sometimes/often find that the other party’s expectations are not what I had expected. Hmmm! Sometimes you are really negotiating with yourself.At the end of the day, every deal is truly a negotiation and what works for one will not necessarily work for another. Take a look at Chester Karass’ books on negotiation — better yet, attend one of his seminars. There is truly an art to negotiating anything.The difference between the PGA and your country club hackers? Technique! Go work on your negotiating technique just a smidgen.Deal guys should have complete commmand of the communication of the deal. They can leverage their personality — hell, take some time to inject a bit of personality into the deal making process and make it a bit of fun — into confidence into a better closing ratio. Why not? They have the most invested and at stake. I would never let a lawyer get involved in deal conversations until the Term Sheet was finalized.Dealsmiths do the right deals and lawyers get their deals right. Subtle but huge difference.
A good read…
This would seem to be a big challenge for a VC coming from I-banking, PE, or Law. A place where you’re dealing with similarly experienced professionals who share the same language, where there’s much less of a person’s soul wrapped up in a deal. As noted by a few above, the entrepreneur is fairly inexperienced and unsophisticated with the terminology and thinking involved.Your stories from your time as a tyro indicate that it can also be a pitfall for a VC associate who has recently moved up to the bigs. Probably for the same reasons as well – associates generally don’t get out much, much to our chagrin.
The same principles apply to doing mid-sized M&A. When acquiring a business and negotiating the asset purchase agreement, it is really important to be candid with the seller about WHY you need certain provisions in the deal, certain pieces of information during due diligence, provisions in the non-compete, etc. The candor enables you to demand the same consideration and explanation for any of their edits. I am sure that in most cases, if I understand what the seller is trying to protect themselves against that I can either solve the problem in the contract or provide enough information to inform the seller on the level of risk. Lawyer-to-lawyer conversations should be limited to such things as jurisdiction. Lawyer-to-seller conversations should not happen.
Perhaps it’s been touched on, but I think the core consideration here is where you are in the process. Marking up a document is perfectly fine if you’re, say, part of an established group collaborating on a pitch deck. But if you’re in the ‘courtship’ phase? The first, and only, rule is common courtesy — treat the person you’re getting to know as if you’re on a first date.
Hello Fred,This conversation visited me again this morning: http://www.iamronen.com/?p=…Wishing you a great weekendAll Things GoodRonen
I am an attorney and I totally agree with your approach. It has happened to me in many occasions that the company gets really upset if the fund makes changes to the term sheet without announcing that to them first. If every businessman went the extra mile they would save a lot of money in legal fees!
ooh. i love the title of your post charles. “lawyers don’t do deals. you do”well said
noted. i’ll try to do more of it. it’s actually some of the easier writing i do.