Exploding term sheets are a term used by startup founders for venture capital term sheets that have an expiration date. A term sheet is a nonbinding outline of the basic terms of a venture capital investment offer, and some have deadlines, after which they’re invalid or “exploded.”
Venture capital firms set the deadlines to reduce “shopping,” which is when founders contact multiple other VCs and try to obtain better deals. Remember, the venture capital firm has put time, effort, and due diligence into this commitment, and they don’t want to expend that effort on companies that aren’t serious about working with them. Shopping also provides a price indication to the rest of the market.
How an exploding term sheet works
There are a variety of different deadlines used, but the general standard is seven days. Basically, you’ve completed your VC pitch, the investor has done a little diligence, perhaps you’ve met with them several times. Now they want to move FAST to lock you into working with them. The venture capital firm wants to close the deal quickly, but you’ll need some time to have the sheet reviewed by your lawyer and potentially negotiate some of the terms. You may see 10-day or 10 working day exploding term sheets, but it’s rare to see more than 10 days. On the other hand, beware any term sheet with an unusually short expiration date, like one or two days. That’s typically a high-pressure sales technique and you need to be careful.
Finally, the phrase “exploding term sheet” is slightly derogatory for something that’s a normal business practice for venture capital firms. VC firms need to set a time limit on their offer – they obviously can’t leave a term sheet “open” in perpetuity! And getting a term sheet is a great day for a founder – you’ve got someone that’s excited about your startup and is ready to invest. If you’ve got more questions about venture capital term sheets, let us know.