The Strength of an Unwritten Rule

There’s an unwritten rule for startups — don’t disclose the terms of a term sheet.

Recently, a frenzy hit the Austin startup community when a founder posted an Op-Ed on Medium disclosing essential terms he received from two different venture capital firms. Legally speaking, term sheets themselves are generally not confidential unless both sides have already executed a mutual Non-Disclosure Agreement (NDA), which VCs typically will not entertain. Therefore, no legal repercussions exist for disclosing terms of unexecuted term sheets.

Does this mean it’s okay for those founders fortunate enough to receive term sheets? Definitely not. There’s an expectation — an unwritten rule — of not disclosing term sheets. A key component to capital infusion is trust. As an attorney, I will very rarely advocate for trust, but this situation is not about the law of contracts; it’s about the law of business and ethics.

Learning to navigate the waters of business relationships is an important trait for founders to develop. Understanding the rationale for particular corporate behavior, like unwritten rules, is even more difficult. I’ll explain with an example I think everyone can understand. If you have ever bought or sold a home you probably know that real estate has a fair market value dictated by attributes like location, square footage and amenities (e.g., two homes with similar lot size, similar square footage and similar amenities will have substantially similar fair market value).

Startups don’t have a fair market value and receive different valuations from different VC firms. This is strongly a result of adhering to the unwritten rule of not disclosing term sheets. Failure to follow the unwritten rule of not disclosing term sheets could create a negative impact on funding where VCs move to match lowest published valuations. This would be bad for startups, because it could squeeze the cap table and establishes fewer resources for growth and later stage funds. It would be bad for investors, because it could cause growth inhibition, which may preclude later stage funding or result in lower valuations at later stages. Most importantly, the overall effect would be bad for innovation and could hinder the progression of emerging technology.

The impact of disclosing term sheets won’t lead to lawsuits (unless you violate an NDA), but it’s bad for a founder’s company and unlikely to lead to a deal. Most importantly, disclosing terms could lead to a negative change in the capital landscape that wouldn’t be good for anyone.

Neil Goro