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Tech startups fear that venture capital investors will cancel their handshake funding deals. They're right to worry, a panel of VCs say.

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  • Venture capital investors say founders should be concerned about deals falling apart in a pandemic.
  • A term sheet is not a legally binding document, so investors are acting within their rights to cancel a deal.
  • Venture capitalists told Business Insider that if a startup can wait to raise new funding, it should wait.
  • But if it can't, their advice is to start by getting commitments from previous investors to speed up the process.
  • Visit Business Insider's homepage for more stories.

It's hard for startups to raise venture capital even in the boom times.

Now, venture capital investors say founders should be worried about firms reneging on term sheets they supply in the middle of a economic crunch.

We asked a panel of venture capitalists if founders should be concerned about pending investment deals falling apart. Of the 18 people who responded, 17 people said founders should have some level of concern.

In normal times, an investor is unlikely to cancel a deal because it could hurt their reputation among founders, and constrain their access to hot deals in the future. But in the current market uncertainty, some venture capitalists may pull back from pending deals as they conserve capital and devote what they do spend to fund their existing portfolio companies.

Five investors told Business Insider that founders should be "extremely concerned," and four people said they should be "very concerned" about deals unraveling. The biggest group of venture capitalists, 8 respondents, said they should be "somewhat concerned."

One person said founders should be "not so concerned."

VCs are acting within their rights

A term sheet is not a legally binding document. It's meant to clarify the expectations around an investment and the timeline for closing — the written equivalent of a handshake deal.

Many deals with signed term sheets end up closing, Semil Shah, an investor at Lightspeed Venture Partners and his own institutional seed-stage fund, Haystack, wrote on his blog in March.

"Most investors know that going back on your word, especially under a time of duress, will ruin reputations," he said.

There were reports in January that SoftBank had reneged on term sheets it supplied to several startups in previous months. Sources close to the startups told Axios that the megafund had pledged to invest hundreds of millions of dollars before making vague excuses to delay closing, and then to kill a deal.

"Watch out, founders," Paul Graham, one of tech's most influential investors, said in a tweet responding to the news. "This is one of the most damaging things that can happen to a startup."

The consequences for a cash-strapped startup are steep

A signed term sheet typically prevents a startup from shopping the deal around to other investors for at least a month or two while the VC firm that has already committed does its final diligence.

The company eats at its cash reserves during that period, with the expectation that money is coming. If six months pass without an investment, the startup could run out of cash and be forced to make cuts.

"We say that companies go out of business for two reasons. You run out of cash, or you run out of cash," said Alexa von Tobel, a founding partner of Inspired Capital. She built a company, LearnVest, during the last recession and sold it for a reported $375 million.

Her advice to startups is to run a capital-efficient business so it doesn't need to raise hundreds of millions of venture dollars. Alexa von Tobel was not among the investors we asked about the likelihood of deals folding.

If it can wait, wait

The consensus among venture capital investors was that if a startup can wait to raise new funding, it should wait.

The number of deals closing is expected to decline over the next few weeks, as investors hoard piles of cash on behalf of their existing portfolio companies. They may be less likely to write checks to companies they have no previous relationships with, because it's harder to get to know the teams over Zoom.

Many venture capitalists told Business Insider that founders should start their fundraising efforts by securing commitments from their previous investors to speed up the process. Those prior backers are more likely to reinvest, and their participation in the round creates momentum that might influence other firms to join, or co-invest as a lead.

For startups, the mission is to get the raise done, and get back to business.

If you're a VC that would like to enroll in the panel, please contact the author of this post.

SEE ALSO: Marc Andreessen's essay on building things overlooks a key point, according to former presidential candidate Andrew Yang: 'Our biggest problems generally don't have market-based solutions'

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