This $750,000 term sheet was going to save the company. The founder was elated. And then, a phone call. The investor was pulling out.

Investors can pull a term sheet for any reason. It’s rare, but when it happens it can leave a company crippled.

Worst of all, it can have nothing to do with the startup.

Losing Your Lead

In a great post on Reddit’s r/entrepreneur sub, a founder describes how an investor gave them a $750,000 term sheet. This term sheet was a lifeline. The startup had practically nothing left in the bank. The founder had drained his personal funds as well.

But in due diligence, the investor said the customer references were negative and gave that as their reason for pulling the term sheet. Many of the commenters say there could be more to the story, and I agree.

The founder probably chose his happiest customers as references. I doubt they’d give such poor feedback.

My suspicion is the lead may not have had the cash to begin with.

Some funds commit to a round before they’ve actually raised the money from LP’s. This is a rotten thing to do, but it happens.

My Experience With a Lead Pulling Out

I’ve only seen this once in my 4 years investing. The lead was a syndicate that didn’t raise what it expected from its members. So, they couldn’t fulfill their commitment to the startup.

The startup had been counting on that money. Now they were left with a dwindling bank account and no money on the way.

Since the round was no longer happening, I didn’t invest either. I’m not sure what happened to the startup, but Crunchbase has no data on them raising further cash.

I’m guessing the company probably folded. This failed round probably contributed to that.

How to Protect Yourself

Legally, investors can pull out for any reason or no reason. But there are ways to avoid this situation and to limit the damage if a round does fall apart.

VC’s that pull out of rounds tend to be no-name investors. They probably didn’t have the cash to make the investment to begin with.

It’s fine to include some obscure names in your round. But having one as the lead is risky.

Similarly, having a syndicate lead your round is a crapshoot. Maybe they can raise the money for the deal, but maybe they can’t.

When the round I was in fell apart, the lead had both these red flags. They were an obscure syndicate based in Europe.

That’s definitely not a good choice for a lead investor.

But there’s an even better way to protect yourself than choosing a good lead: getting to break even.

If you’re at break even when you raise money, you’re in a position of strength. You can dictate the terms. And if the round doesn’t happen, it’s no big deal.

Wrap-Up

Losing a lead investor can devastate a company. And unfortunately, it often has more to do with the investor than it does with the startup.

Protect yourself! Choose a lead with a track record and a good reputation. And get to break even before you start fundraising.

This way, whatever happens, you will survive.

More on tech:

Is Your Vision Big Enough?

Five Things Founders Should Never Pay For

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