NEF Panel Discussion: Term Sheets - Understanding What Your Investors Want

The Sep. panelists were: Prem Bodagala, Director, Invest Michigan (MI Pre-Seed Fund 2.0); Mike Flanagan, Director of Capital Programs, Ann Arbor SPARK; Stewart Nelson, Angel Investor and CEO, Mayasil, LLC; along with Bill Mayer, Vice President Entrepreneurial Services, Ann Arbor SPARK, serving as moderator.

Term sheets are confusing. Here are several tips from the discussion:

  • The top four items to have on a term sheet – valuation, type of instrument, min/max amount of raise, and governance/board structure
  • Companies can raise too much money too fast where the financials do not support capital needs. As a result, entrepreneurs can give away more of their business than they have to.
  • Have the convertible debt convert time for about 18 months, and negotiate to 24 months if you can.
  • Basic two types of instruments are used:
    • Convertible debt where a company borrows money from investors which is later converted to equity. It is difficult to value companies with little traction. Investors are favoring priced rounds where the company has enough traction to value it. Being over or under valued can hurt the company. Investors look to double or triple the valuation between investment rounds so the ‘price needs to be just right’ – the Goldie Locks principle.
    • Direct investment in the company
  • Executive Summary dos & don’ts
    • Financials, include number of customers or units sold along with revenue figures
    • Be able to justify your sales ramp up figures
    • Have an experienced management team
    • Do not try to be everything to everyone, be focused
    • Thorough market strategies are helpful
    • EBIDAs > 50% = red flag that financials have significant errors
    • Underestimated marketing expenses are a red flag, count on around 60% - 70% of sales
    • Include the cost to acquire a customer and the life time value of a customer to understand customer churn rates
  • Solicit investors that can help the company by adding value with operations in addition to money
  • Advice to entrepreneurs to increase their funding chances
    • Prepare yourself
    • Know who & what kinds of investments the investor invests in
    • Have rehearsed answers to probable questions
    • Have a good presentation
    • If you do not have an answer for a particular question, say you are working on it
    • You may have to take longer to grow the business if you are ahead of the market
    • Continue running the business while raising capital

Many thanks to the panelists for their insightful expertise.