Day 10 Due Diligence and Term Sheets

Today is my tenth day at CoreNetwork Fund, the beginning of my last week here. In the morning, I spent about half an hour planning out today and this week’s independent study activities. Today I mainly focused on learning about Due Diligence and Term Sheets. The rest of the week will be a wrap up for reading Venture Deals, web development, and my fundraising project. Looking back, I have learned a lot about VC comparing the first day I stepped into this unfamiliar and small office on the 7th floor with a nice view. I look forward to finishing off this week strong and enjoy the rest of the time here.

Erik and I touched base about the idea of Due Diligence last Friday, and today after more research, I would share what I learned about it here. Though Due Diligence is quite a confusing and complicated term in VC, it is too relevant to not talk about. In short, it is the process that investors use to evaluate the business and legal aspects of a potential company. For example, some steps may include outreach, market research, financial research of companies, communications. In general, Due Diligence can be divided to 3 sequential stages:

1. Screening due diligence

Venture funds review and evaluate hundreds of business opportunities over the life of the fund and use predetermined criteria to identify which opportunities to focus on as possible investments. Usually, the most fitted 10 out of 100 will be selected for a more detailed review and communication with the CEO.

2. Business due diligence

A senior team member at the VC firm will review those selected companies’ management team, market potential, the product or service (and the need it meets) and the business model.

3. Legal due diligence

At last, the lawyer at the VC firm will do a legal review and answers questions for the company who is receiving founding.

After understanding Due Diligence (a term that has actually been confusing me since I first started exploring VC, but it is now making a lot of sense after 2 weeks into the internship), I started looking at term sheets (one of the must-knows in VC). A term sheet is an outline of material terms that both VC and the company agree for the investment transaction. Something that needs to be clarified about term sheets is that it is not binding. Though in my last blog (when I was talking about the process of a VC deal), I said signing the term sheet is a commitment to invest, term sheet is only subject to actual documents, due diligence, and closing documents. Practically, when investors sign the term sheet, they do ended up accepting the terms and invest what they committed on the term sheet (since the VC community isn’t that big, reputation plays a big role for getting up the ladders). Rarely in cases like the VC running out of money or the startup defaults or fail to achieve a tranche milestone by a certain quarter, investors can stop the term sheet agreement and stop investing. Besides some useful PPT and the chapters in the book I used for learning about term sheet, I thought the best way to learn it is to see an actual one. I asked my sponsor and Erik kindly gave me a copy of one of their company’s term sheet to look at and practice applying the knowledge I had just learned.

Sample Term Sheet

Note that term sheets are more complicated in the nature when it is written in real life, there are four provisions that protects VC's interests, if you are interested, I have an article link for you that explains it pretty well: https://pitchbook.com/news/articles/four-term-sheet-provisions-that-protect-vc-interests

Today I have reached my overall goal of learning How Venture Capital Works through understanding two very important concepts in VC--Due Diligence and Term Sheets. By understanding the process of due diligence, I satisfied my first goal of learning the factors of evaluating startups. As for my second goal of knowing the process of a VC deal, I think I hit that by learning the process of due diligence because they are basically the steps of evaluation (which is the main part of a VC deal). By reading chapter 16 in Venture Deals, I gained a general idea of why Term Sheets exist and what are in term sheets, which also contributed to achieving my third goal of reading the book. Today has been a fulfilling day of learning more basics in VC and looking at actual documents. Tomorrow, I will get my new task of updating the website, which I am very excited about!