Exploding Term Sheets and Entrepreneurship

A pair of posts on TechCrunch got me to thinking about the concept of an exploding term sheet. Or more broadly, an exploding offer of any kind.

With the recent launch of Capital Factory, TechCrunch notes that the number of Y Combinator style incubators is increasing, and the niche is getting more competitive. So competitive, TechCrunch states, that some of the incubators are resorting to exploding term sheets to lock up good companies. Arrington thinks these term sheets are nasty beasts. I disagree - they're totally irrelevant.

The idea is that the incubator makes an offer with terms that are set to expire, sometimes very quickly. This puts a good deal of pressure on the entrepreneur to take the deal while they have the chance.

But here's the thing about exploding terms: they do absolutely nothing to change the dynamics of the marketplace - they are purely psychological tools and can be safely ignored.

I've seen them in real estate, for example. Such and such company will make an offer to buy a property, but the offer is only good for a week. Lets consider two cases to illustrate my point:

Case 1: It's 2007, and the real estate market is cranking at full throttle. The exploding term sheet is pure bullshit. The property owner has all the cards, and can react to an array of buyers in the time frame of his choosing. The exploding offer does nothing but make the purchaser seem flakey, because when push comes to shove, he'll wait.


Case 2: It's 2009, and nobody wants real estate. The buyer has all the power, because the seller wants out and there are no other buyers. If the seller delays too long, the buyer may find something else to buy. It's in the seller's interest to act as quickly as possible before the deal falls apart. The exploding offer again does nothing, since the market has already provided sufficient motivation to get things done quickly.

So when you get a term sheet with an expiration, ignore it. Act as quickly or as slowly as the realities of the market will allow.

And if you're on the other side of the table, don't make an exploding offer. At best you come off as pushy, and at worst, you'll be embarrassed when you don't follow through with a hollow threat. A better tactic is to simply state that the offer is good until it's not - which is really the truth of the matter.