Trust and Control: The Value Effect of Venture Capital Term Sheet Provisions as Risk Allocation Tools

Abstract

The parties to a venture funding agreement are in a state of coopetition. The parties account for perceived risk in the entrepreneur-investor relationship through varying levels of control demanded from and trust afforded to the other party. The level of risk perceived by each party may differ along individual aspects of the prospective equity deal. The provisions of the term sheet delineate the subjective risk perceptions of each party to the transaction by allocating control or trusting a party with decision-making rights. When negotiating term sheet provisions, a party should seek to understand and recognize the risk perceived by the other party and attempt to afford the level of control or trust necessary to achieve a relational agreement that provides the greatest value for the parties collectively. An optimal allocation of control and trust adequately captures the perceived risk of each party, promotes cooperation between the parties, and ultimately facilitates the performance of the business venture. Understanding the subjective risk perceptions of each party to the investment transaction will facilitate the objective of negotiating a term sheet that maximizes the value created for all parties.