In defense of exploding term sheets

There’s a lot of content out there arguing that exploding term sheets—ones that expire after a set amount of time, whether or not they’re accepted—are bad. Some of this comes from founders who do not appreciate the pressure; some if it comes from VCs who want to emphasize their own founder-friendliness. The reality, though, is that all term sheets explode. The only variable is when.
I’ll even go one step further: If term sheets didn’t explode, fundraising would be much harder for founders. During a well-run fundraising process, founders are largely in control. They can dictate when to pitch and when to release information. They’re the ones who choose if and when, ultimately, to sign an offer. At the extreme, this can produce comically narrow demands: Pitch Monday, offers Tuesday, decision on Friday. (To be fair, sometimes this works.) Venture capitalists are left in control of one thing: whether and when to say yes or no.
Now, in fully liquid or public markets, investors can take as long as they want to decide whether to buy or sell—and if the fundamentals change in the interim, well, they can go on their merry way. But in VC rounds, the default assumption is that, once a VC says yes to an investment, they can’t take it back.
This is kind of weird.
Term sheets aren’t actually contracts, and yet they’re considered to be (mostly) binding. That means once an investor makes an offer, they’re exposed to two types of risk: first, of course, that their investment turns out to be a bad one, but also the indefinite opportunity cost of spending a lot of time working on, thinking about, and allocating funds to a deal they might not win.
If we multiply that second issue by the number of deals an investor might want to do, you start to run into an even bigger problem. Investors can only evaluate or commit to a certain number of deals at a time. An investor who cannot control the lifespan of her offers would quickly run out of bandwidth to evaluate new deals. This would be bad for everyone. If an investor is willing to make a bet, she should be able to know when to expect an answer.
Process uncertainty also creates issues for founders, who have a right to know when to expect a yes or no. But once an offer is made, founders would prefer if it stayed open until they can make a decision, however long that takes. VCs prefer an offer that expires relatively quickly.
To me, it certainly seems as if both sides want something reasonable. What’s missing is a common set of rules to determine what’s fair. So, here’s what I propose: Founders should have at least as long to decide whether to accept the terms as the VC took to decide to make an offer. I'll explain.
If an investor makes a decision to invest within 24 hours of the start of a fundraising process, then a term sheet with a 24-hour clock seems reasonable. Think of it as a bonus for VCs who make decisions quickly. Their time in uncertainty is small, so they should be able to process more deals in less time than slower moving funds.
At the other end of the spectrum, investors who need more time to deliberate should extend founders the same courtesy. The VC could even cast this as an advantage—“Yes, we take time to get to know you and think deeply and stuff. But when we make a decision, we make it with conviction, and we will romance you and woo you and convince you, dear founder, to take our offer.”
VCs could also publicly commit to a certain timeline. “Once we meet you for a pitch meeting, we’ll make a decision within a week. Once we give you a term sheet, you’ll have a week to decide.” A day on each side could work. A month on each side could work. As long as both sides understand the terms ahead of time, the trade is even.
From a founder’s point of view, too, all of this should seem fair. And by that same token, if a founder needs an offer by a specific date or time, they should return a decision on that same time scale.
That said, negotiations are messy, and the reciprocity principle won’t work perfectly every time. Sometimes a founder will push the deadline too hard and scare everyone off. Sometimes a VC will do the same. But fun fact: exploding term sheets don’t literally explode. A VC can always decide to extend another offer if they’re still interested after their deadline has passed, or even ignore the deadline altogether. This is simply a negotiating tactic.