Venture Capital No Shop Clause: What to Know
Say you issue a term sheet to a startup you wish to invest in. What’s stopping that startup from turning around and using your term sheet to leverage better offers from other investors? How can an investor safeguard the time and money required to perform their due diligence without risking another investor swooping in at the last minute? Scenarios like this are why VCs typically include a “no shop” clause in their term sheets.
While most term sheet terms are non-binding, the no shop clause is almost always legally binding because running afoul of this term can scuttle a deal before it’s complete. In this article, we’ll provide a deep dive on no shop clauses for VCs: what they are, why they’re used in venture deals, and how VCs should approach no shop clauses.
What is a No Shop Clause?
A no shop clause (also referred to as a “no shop agreement,” “no shop provision,” or “exclusivity clause”) prohibits the company and founders from soliciting investment offers (incl., negotiating with other investors, or engaging in talks that could lead to an investment offer) from other VCs for a set period of time. During this given time period (typically 1-3 months), the founders and existing investors are expected to work together towards a finalized deal. Sometimes, a no shop clause will also require the company to notify the investors if another investor inquiry comes through, even if the company did not solicit the inquiry itself.
Here’s what the no shop clause reads like in an NVCA model term sheet:
“The Company and the Investors agree to work in good faith expeditiously towards the Closing. The Company and the founders agree that they will not, for a period of [______] days from the date these terms are accepted, take any action to solicit, initiate, encourage or assist the submission of any proposal, negotiation or offer from any person or entity other than the Investors relating to the sale or issuance, of any of the capital stock of the Company [or the acquisition, sale, lease, license or other disposition of the Company or any material part of the stock or assets of the Company] and shall notify the Investors promptly of any inquiries by any third parties in regards to the foregoing. The Company will not disclose the terms of this Term Sheet to any person other than employees, stockholders, members of the Board of Directors and the Company’s accountants and attorneys and other potential Investors acceptable to [_________], as lead Investor, without the written consent of the Investors (which shall not be unreasonably withheld, conditioned or delayed).”
The “good faith expeditiously” language ensures founders don’t try to run out the clock on the no shop clause so they can find a better offer. It also encourages investors to complete their due diligence and their investment within a reasonable amount of time.
VC Brad Feld, author of the book “Venture Deals,” likens a no shop clause to “serial monogamy,” stating that it ensures the company isn’t “running around behind [your] back just as you are about to get hitched.”
What Happens if you Breach a No Shop Clause?
Running afoul of the no shop clause will likely jeopardize the investment, as the VCs may believe you’re no longer negotiating in good faith. Depending on the terms of the no shop clause, breaching this provision may also trigger a “break-up fee” if the deals falls apart and the company agrees to a deal with another investor before the no shop clause expires (note, this break up fee may only apply if the VCs were not given the opportunity to participate in the deal on the same terms as the new investor).
Additionally, there may be reputational harm associated with breaching the no shop clause. A spurned VC may be inclined to caution other funds from investing in a startup, if said startup breached exclusivity.
Why do VCs Want a No Shop Clause?
No shop clauses make sense for VCs and founders for a handful of reasons:
- Certainty. A VC issues a term sheet to indicate they intend to make a financial commitment to the business and ensure both parties are aligned on the structure of the deal before spending time and money drafting complex financial documents. After the term sheet is issued, the VC may perform additional due diligence and negotiate with the founders on the specific terms of the investment. The no shop clause ensures this post-term sheet process isn’t disrupted by outside investors, and is especially important in competitive rounds where multiple VC firms may be vying for allocation.
- Simplification. A startup will typically receive multiple term sheet offers they negotiate against eachother before signing one. The no shop clause can benefit founders by legally obligating them to ignore all the outside noise once they sign a term sheet with a specific VC. This can streamline the negotiation and due diligence process and save all parties some money on legal fees.
- Strengthen relationship. As Brad Feld explained, agreeing to a no shop clause demonstrates commitment on behalf of the startup, and fosters good will between the negotiating parties.
Confidentiality Agreement vs. No Shop Clause
In a standard term sheet, a confidentiality agreement accompanies the no shop clause. The confidentiality agreement stipulates that the startup can not disclose the terms of a term sheet offer to outside parties (save for its officers, accountants, attorneys and other parties material to the execution of the deal). This term can be viewed as an added layer of protection beyond the no shop clause. By legally requiring that the startup not share the details of an offer with other investors, it further ensures the startup won’t leverage the offer to try and get a better deal.
Considerations for a No Shop Clause
While no shop clauses are standard in venture deals, there are two items both VCs and founders should consider before agreeing to the no shop clause.
- Length of no shop clause. Founders will want to pay special attention to the period of time the no shop clause is in effect, as it severely limits their flexibility. Founders will want to make sure they feel very good about the proposed deal structure prior to engaging in this commitment. A shorter not shop clause period is generally more appealing to founders. Also note that some no shop clauses come with an automatic extension clause, which has the effect of extending an exclusivity period without requiring the investors to formally request an exclusivity extension.
- Leverage. All negotiations are a function of leverage. Investors in a strong position can typically demand a long no shop clause period. However, if a startup is seeing strong demand, it has more leverage to demand a short no shop clause period—or do away with the no shop clause entirely.
No Shop Clause FAQs
Is a no shop agreement legally binding?
A no shop clause is one of the few terms in a term sheet that is legally binding because disobeying the no shop clause can have a material impact on the outcome of a deal.
What happens if a startup fails to comply with no shop clause?
Failure to comply with the no shop clause can jeparodize a venture deal. If a startup doesn’t comply, it can be seen as a failure to negotiate in good faith. If an investor does not comply, it likely means they were unable to complete their due diligence and make a formal investment offer within the no shop period.
Do you always include a no shop clause?
VCs will almost always include a no shop clause in the term sheet. However, a startup with leverage may demand a short no shop period, or refuse to agree to a no shop clause altogether. However, refusing to agree to a no shop clause can be a red flag for investors, as it signals the startup may not be interested in a fair negotiation.
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