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No-Shop Provisions
Recently, I’ve seen a few deals go south where a founder had strong momentum and signed a term sheet (with a no-shop provision). The deal didn’t close, and they were stuck with no leads or cash. So today, I want to discuss no-shop provisions and how you should approach them.
A no-shop provision is a term in a term sheet that says that for the next (typically) 30-90 days, you won’t negotiate with any other VCs and will exclusively negotiate with the VC who signed the term sheet. They exist because VCs want to know they won’t lose the deal if they need 1-3 months to complete their due diligence.
Before we move forward, I want to remind everyone that a term sheet is NOT a legally binding investment document. So if a VC signs a term sheet, they DO NOT need to invest in you. It is just a document that outlines the terms under which they are considering investing in you. That being said, some parts of the term sheet that won’t be incorporated into the final investment agreement (like the no-shop provision) are legally binding.
How do you deal with no-shop provisions?
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Offer a right of first refusal instead - A right of first refusal means that (i) you can keep raising until the money is actually in your account, (ii) if you find a better offer, the VC has the option of matching it instead of losing the deal. This can be a great compromise because the VC doesn’t have to fear “losing” the deal, and you can maintain your fundraising momentum until you know for sure that the deal is closed.
Refuse the no-shop - Many founders aren’t in a position where they can risk losing a term sheet, but often, a no-shop (unless it comes from a top-tier, reputable VC) can be a much more significant risk than rejecting a term sheet. I’ve seen no-shop provisions with up to 12-month periods, which means that as a founder, you have to wait 12 months for them to finalize the investment and can’t raise from anyone else during that time. A no-shop also removed the market pressures from a VC, giving them more comfort in taking their time to do a deep due diligence process and more leverage if they decide to re-negotiate terms.
Ask for a break fee - I’ve never personally seen this work in a VC deal, but they are common in M&A deals. In short, it gives the investor their no-shop and 1-3 months to do their due diligence, but if they back out, they need to compensate you financially. If you are a seed or pre-seed company, I would consider doing this and asking for your current runway for six months as the break fee. So, if you currently spend $10k monthly, ask for a $60k break fee. That way, even if the deal falls through, you have your runway covered for the DD period + 3 more months to get back to fundraising. In that scenario, you are probably looking to grow to about $50k per month and raise for a 24-month runway, so raising a total of $1.2M. $60k as a break fee, being 5% of the deal, seems fair. Again, I’ve never seen this work, but maybe we can normalize it.
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