Most VC termsheets are dangerous. If entrepreneurs really knew how much time VCs spend trying to find ways to warp the thing in their favor they would demand new term sheets written in a clean room by third parties.
So why do VCs write such things? Because they can, of course, but the real high-gloss VC answer is that self-serving term sheets goose returns. Yes, such things can admittedly increase returns, but it’s generally not worth the candle. Over-aggressive term sheets create bad blood between entrepreneurs and VCs, they waste time, and they have a minor impact if you pick good deals.
The low-gloss VC answer is nervousness. Most venture capitalists have no gut for the business — they don’t know good ideas from bad ones — so they are forced to rely on thumb-sucking spreadsheet analysis and tricky term sheets to make themselves feel better. They alibi the 3x liquidation preference and anti-founder rights clause that at least if things don’t work out they’ll be able to salvage something.
Dan Primack has a quote from one of his readers on the subject this morning, and he says more or less the same thing:
… if most VC’s did a better analysis of the cashflow forecasts/possibilitiesof the companies they invest in, and spent less timewriting tortuous term sheets, they might get (even) better returns. Capital appreciation is driven by the underlying assumption that eventually there will be a big cashflow payback. It may be well beyond
the average VC’s time horizon, but ultimately the basic rules of economics kick in, and, as Microsoft’s mega dividend a while back shows, cash is still king, even in the technology world.