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As a proud entrepreneur, you’re likely to be impassioned with a bold vision that keeps you up at night. You’re on top of your company’s growth metrics. You’ve recruited a fantastic team. You have an excellent pitch ready. You’ve impressed one investor after another in your preliminary conversations. However, it’s possible that you, like many other entrepreneurs out there, fumble what comes next — negotiating with your investors. This is entirely understandable; negotiating in general is a nuanced art, and when high stakes and seasoned investors are involved, it’s easy to get nervous and make mistakes.
As your negotiations progress, you need to simultaneously get off on the right foot, maintain your leverage, win the investor’s trust, think with an open mind and arrive at a mutual understanding. You don’t want to lose ground or give up too much control. And you certainly don’t want to lose the investment! Complex though it may seem, taking the right approach, led by the right attitude, and backed by the right experience, can help you become a maestro negotiator.
As Victor Kiam, an American entrepreneur, once said, “A negotiator should observe everything. You must be part Sherlock Holmes, and part Sigmund Freud!”
Here are our top seven tips to help you better negotiate deals with your investors.
1. Keep the big picture in mind
Closing out on negotiations and finalizing term sheets can get lengthy and complicated. It’s easy to get overwhelmed and get carried away by extraneous details at the cost of the bigger picture. As an entrepreneur, you want to remember that the larger objective is for you to win your investment on terms that are supportive to you, so that you can build your company in the best way possible. At the same time, you must also remember that it’s your responsibility to make your investor feel secure.
Term sheets are not just about money; there are several other aspects to discuss. However, as you go along, make sure you’re focusing on negotiating the essential parts for your startup, and not arguing over irrelevant things that will drive your deal away. A lot of the term sheet could be boilerplate material that usually stays untouched; for instance, clauses dealing with disclosure of information are fairly standard. It’s also common for investors to want some representation on the board for some control in the growth of the company. Most investors will also insist that the founder commits exclusively to this one business for the short to medium term, thus increasing the chances of the company (and their investment) becoming successful.
Instead of approaching the negotiation with hostility, try to think from your investor’s perspective. Focus on showing how capable you are, instead of fighting them over their preferences. The more you can position the negotiation as a win-win situation by inspiring everyone to keep their eyes on the prize, the more fruitful your discussions will be.
2. Stay in control of equity matters
Entrepreneurs often get carried away when they find the right investor and agree to give away too much equity too soon. While this may not be a problem for founders looking to only raise one round of funding, it does get problematic in cases of multiple rounds of funding. Too much equity given away in round one deters investors in rounds two and three of fundraising.
Additionally, you want to carefully consider what shareholding will be diluted in subsequent rounds. If you have an anti-dilution clause with your first investor, your deal becomes more complicated. Venture capitalists are generally keen to have anti-dilution clauses while angel investors might be more open to the holding structure. As an entrepreneur, you want to weigh your options and stay on top of equity distribution from a future perspective.
So, think long term: Understand the implications of the equity given and the expectations with the dilution clauses you sign.
3. Avoid legal lingo
As your negotiation progresses into legal waters, it will be time to bring out the lawyers. In some cases, this disrupts negotiations; entrepreneurs forget that at the end of the day, it’s their relationships with the investors that are paramount.
At the very outset, you want make sure that your lawyer is on the same page as you. Its naturally advisable to select a lawyer with prior experience in investment deals. Once you’ve chosen a lawyer, you want to provide a very thorough brief. Whether your arrangement with your lawyer is by “full package” or by hourly billing, you want to keep the focus on negotiating the relevant things. The last thing you want is your lawyers disrespecting your investors, wasting their time with trivialities or turning an easy-going conversation into a hostile one over small legal clauses. Focus on building relationships with your investors based on trust.
4. Take your promises seriously
It’s a small world out there, and word spreads quickly! By overpromising to your investors, you’re putting your own reputation at risk. Some entrepreneurs switch from one investor to another, not anticipating that they might talk to each other. Others re-negotiate when they realise they can’t deliver what they promised.
It doesn’t matter if your correspondence with your investors is not yet formalized in writing. You could be conversing over the phone or in person; irrespective of the medium of communication, you want to be known as a person of your word. Guard your reputation. You never know who might be able to help you tomorrow. You may need to raise several rounds of funding. You may need to access a web of agents, investors, advisory groups or syndicates. You can win respect by keeping things simple and taking your promises seriously.
Be realistic in what you offer, always be ethical and think about others’ perspectives in addition to your own advantage. It’s not just about what you do; it’s about who you are.
5. Anticipate various scenarios and prepare in advance
When the stakes are high, it’s never wise to ignore the homework. Yet, many entrepreneurs often find themselves fumbling in the middle of a negotiation because they didn’t anticipate the turn it would take.
Sometimes it’s easy to forget that many roads can lead to the same destination. Negotiations with investors may take one of multiple routes. Entrepreneurs who haven’t assessed different scenarios in advance are not able to creatively come up with solutions or counter-proposals. This often prolongs negotiations unnecessarily and sometimes even derails them.
You can learn from such mistakes and ensure you prepare in advance. Study various exit scenarios. Look up similar fundraising deals. Do your homework on your investors’ preferences so that you’re not reaching out to random investors. Ensure you know your options irrespective of what is offered to you. With this approach, you’ll navigate your discussions with confidence, and you’ll build calm instead of chaos. And you’ll increase the probability and the speed of closing the deal you want.
6. Clarify your rights
Startups tend to focus a lot on the amount of equity in their negotiations and not enough on the rights the various parties can have. The amount of equity isn’t everything; it’s not necessary that two investors holding the same amount of equity have the same rights.
Investors will typically insist on placing members from their teams on your board. They will also insist these members have voting rights, for guidance in management and growth of the firm. Too much external control, however, will impact your future decision-making and business development. We’ve all seen brilliant startups and well-respected organizations stunted in their growth because of indecisiveness of the overall board or differences in vision.
Spend enough time deliberating the rights of your team from the get-go. Make sure your initial team has a say in business decisions in the short term as well as the future. You want to account for rights keeping in mind subsequent funding rounds as well and retain control of your company throughout.
7. Align with the right investors
As you’ve learned by now, investments are not only about money! In bringing the vision of your company to life, you’ll need support from trustworthy people with similar mindsets. You want to focus on the quality of your investors. You want to partner with those who respect and align with your potential and thinking and who can guide you. You don’t want to be using your energy being constantly misunderstood, fighting manipulation and preventing your board from out-voting you.
In the same way that investors conduct their due diligence on founders before writing them a check, you must carefully study your potential investors. Go through their profile. Check if they’ve previously invested in similar businesses. Speak to other founders from their portfolio companies and try to understand how effective the relationships were. Ask yourself if the investor knows about your market, believes in the potential of your opportunity and can support you in growing better and faster.
Remember that just as there are multiple startups around the world raising billions of dollars, there’s also a lot of money waiting to be deployed. Make sure your first deal is the best deal ever.
Choose the strategies that work best for you, practice executing them repeatedly, and you’ll find yourself elevated from an amateur negotiator to the pro league!