In many cases it’s worse to have your investor back out on a term sheet then it is to never be offered one. Before popping the champagne bottles and celebrating what looks like an offer, it’s best to remember that VC term sheets are not legally binding. While it’s certainly a feat to be offered one, angel investor and Hunch cofounder Chris Dixon wrote a great piece reminding startup entrepreneurs what can happen if your potential investor changes his or her mind.
In a recent blog post Dixon explains the unfortunate circumstance of one of his portfolio companies. Says Dixon, “Yesterday, one of the 40 or so startups I’ve invested in (either personally or through Founder Collective had a well-known VC back out of a term sheet for no particular reason besides that they decided they no longer liked the business concept. It’s the first time I’ve seen this happen in my career.”
Dixon explains that generally VCs only do this in extreme cases of fraud or upon finding that founders have criminal backgrounds. Because of this, any rescinded term sheet can be devastating for startup companies.
As is the case with startup CEOs, word travels fast on Sand Hill Road. In a recent presentation I watched as one founder revealed his funding from several well-established angel investors. Those in the room perked up as soon as they realized that major players were already involved in the company. The same logic can be attributed to the loss of a term sheet.
When one firm backs out of an offer, others who may have been interested will look at you under extreme scrutiny. Although Dixon’s case appears to be an anomaly, it’s important to remember that as an entrepreneur you should remain ever-diligent and avoid over-promising returns and results.
