Venture Capital Term Sheet Negotiation — Part 21: No-Shop and Confidentiality Provisions

This post is the twenty-first and final in a series giving practical advice to startups with respect to understanding and negotiating a venture capital term sheet.

In the prior twenty posts, we provided an introduction to negotiation of the term sheet and discussed binding and non-binding provisions, and discussed valuation, cap tables, and the price per sharedividends on preferred stockliquidation preferencesthe conversion rights and features of preferred stockvoting rights and investor protection provisionsanti-dilution provisionsanti-dilution carve-outs and “pay to play” provisionsredemption rightsregistration rights,  management and information rightspreemptive rightsdrag-along rights, representations and warranties, rights of first refusal and co-sale, closing conditions and expenses,non-competition and non-solicitation agreements, non-disclosure and developments agreements, board matters, and founders’ stock. In this final post, we will discuss no-shop and confidentiality provisions.

One of the last sets of terms in the NVCA model term sheet is the “No Shop/Confidentiality” section. The terms in this section are binding even if the venture capital transaction is never completed. The no-shop obligation requires the company and the founders not to solicit any offer of an investment in the company by a party other than the venture capital investor for a certain period. The investor may also require the company and the founders to agree not to solicit any offer for the acquisition, lease, or similar of the company, whether by stock or asset purchase. The company is required to work “in good faith expeditiously” towards a closing of the venture capital transaction — this language is intended to prevent the company from stalling out the deal if it comes to believe a better opportunity might be in the offing after it has entered into the term sheet. The company and founders are required to notify the investor of any third-party inquiries promptly; this includes offers the company and founders did not solicit or encourage.

The NVCA model term sheet offers, as an option, a liquidated damages provision requiring the company to pay a specified “break-up fee” if it breaches the no-shop and actually closes an investment or sale transaction before a designated date. The language might provide that the break-up fee only applies if the venture capital investor is not given the opportunity to participate in the transaction on the same terms as the other party. The NVCA model term sheet notes that break-up fees are not common in venture capital financing, but could be considered if the company is likely to be sold before the closing, such as in a later round.

The confidentiality provisions provide that the company may not disclose the terms of the term sheet itself to anyone other than its officers, directors, accountants, attorneys, and other potential investors without the venture capital investor’s consent.

The no-shop and confidentiality provisions are standard (although not universal) in term sheets. The only points that the founders need to worry about are the length of the period during which they cannot actively seek another investor or buyer (if applicable) and whether the investor presses to include the optional provisions extending the no-shop to acquisitions and imposing a break-up fee. The no-shop period is typically one to three months from the date the terms are accepted; the shorter the period, the more favorable to founders, although they should recognize that due diligence and document preparation take a certain amount of time and the founders’ own responsiveness plays into how quickly those activities can be accomplished. The application of the no-shop to acquisitions and the break-up fee are issues for later-stage companies to consider. Founders should recognize that a no-shop obligation with a specified period facilitates the transaction for both parties: the investor has some degree of assurance that the founder is committed to doing the deal and will hold off seeking other investors for the no-shop period, and the founders can expect the investor to endeavor to complete its due diligence, finalize the detailed terms, and deliver the transaction documents before the end of the period.

This concludes the series on venture capital term sheet negotiation. We hope you have found this series valuable and educational.

This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

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Alexander J. Davie

Alexander J. Davie

Alexander Davie is a corporate and securities attorney based in Nashville, Tennessee. Businesses of many varieties rely on his counsel and judgment throughout all stages of their growth. In particular, fund managers and investment management professionals seek the expertise Alex gained when he served as general counsel to a private investment fund. Alex also has significant experience and enjoys working with companies and entrepreneurial ventures, especially within the technology industry. As a believer in technology's ability to enrich people's lives and allowing people to connect with each other in new ways, he is passionate about helping tech startups achieve success. He is active in Nashville's startup community as a mentor at the Nashville Entrepreneur Center and participates in numerous other events geared towards making Nashville a nationally ranked location for starting a business.

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