Time zones, languages, continents and business models may change as you cross the Pacific, but the Private Equity Term Sheet remains the same.
This is my conclusion after seeing the first Term Sheets arrive for our China First Capital clients recently. This is a happy moment – not so much for ourselves, of course, but for the entrepreneurs and PE firms we are fortunate to work with. For me, seeing these first Term Sheets is cause for reflection and, I hope, some insight, on the constant truths of the equity investment process.
I’ve been involved in quite a few Term Sheets for US venture deals over the years. I was surprised to find the Term Sheets this week very familiar, even though the investor and the target company are both based in China. In every other respect except the Term Sheet, the circumstances couldn’t be more different than a typical US venture deal — the governing law, the industry, the company’s ownership, the likely timing and nature of the exit.
So, why, despite all these vast differences, are there such deep similarities in Term Sheets? Start with the fact that there’s commonality in the approach of all good institutional investors: they all must exercise fiduciary responsibility on behalf of those whose money they are investing. This, in turn, means the due diligence process needs to be thorough and professional, and the terms under which investments are made be sufficiently protective of the source of the invested capital.
This fiduciary duty is made concrete in many of the standard provisions of a Term Sheet, whether that Term Sheet originates in Palo Alto or Shanghai. Indeed, the majority of the text in a Term Sheet is there to protect the fund’s Limited Partners from bad outcomes: share structure (preferred), board seats, liquidation preferences, anti-dilution provisions, preemptive rights, matters requiring special approval, performance guarantees.
So far so familiar.
The other big element of any Term Sheet, of course, is where the PE or VC firm is asserting primarily its own interests. The two most obvious areas: expiration dates and “no shop clauses”. I was mildly surprised to see these in the Term Sheets recently submitted to clients of China First Capital. I’d mistakenly thought the “no shop clause”, in particular, expressed a very local, American legalistic reality. In business negotiations, Americans need to specify as much as possible in writing, to protect against the ultimate evil of American business life: business litigation.
Chinese, though, seem to have a far less obsessive need to document everything in writing, and certainly don’t have the same persistent, gnawing fear of litigation. It’s a “guanxi” society, where trust between individuals forms a more insoluble bond than any contractual term.
A part of me, therefore, wishes the “no shop” clause hadn’t crossed the Pacific. I view them as the Pre Nuptial Agreement of the PE and VC investing world. They can create an air of mutual distrust, at a time when both sides are trying very hard to build a lasting partnership.
A Term Sheet should serve the same fundamental goal: to allow great PE investors to put capital to work in truly outstanding investment opportunities, while limiting risk for the owners of that capital. I’m excited that the Term Sheets I’ve reviewed this week, once finalized, will achieve this goal, and achieve phenomenal outcomes for everyone involved.