Last week, a friend of mine was meeting with a potential investor for a new venture he was kicking off. He called me to discuss and seek advice; he had all those questions on how to split equity, how much to ask for… basically how to handle the “negotiation.”
This is a general phenomenon, a common challenge to all entrepreneurs, and perhaps especially tough for product-focused techies. “Negotiate your startup’s success” is a series of four articles providing tips and guidelines for entrepreneurs in their negotiations at different stages of their startups. This article provides 10 tips for negotiating with investors. The next three articles will tackle negotiations with employees, and suppliers and finally the exit negotiation.
While much of the negotiation’s success depends on intuition, adaption and experience, there is a framework, a series of guidelines and tips that have proved beneficial for entrepreneurs during their negotiations. Below is a compiled list of the top 10 do's and don’ts for negotiating with investors:
- Look beyond the win-win and aim at creating
value. The concept of creating value at a negotiation
table was first documented by negotiation guru prof. Robert Fisher
this video). The best attribute of a successful negotiator is
asking questions and the ability to understand the other party’s
desired outcome and requirements beyond the obvious. Beyond being
interested in investment and equity, many investors are looking to
create a source of deal flow; building an ongoing partnership with
them will add value to the deal and increase the satisfaction of
both parties. Essentially, asking and investigating is always worth
your time. Whatever happens, don’t try to create a win-lose
situation with your investor. Always keep in mind that your
relationship with the investors is for the long term. If they don’t
invest in this venture, they will on the next one.
- Work on your relationship with investors – build
trust. The key to any successful win-win negotiation is to
build mutual trust between the parties involved. This applies to
negotiations with investors, especially early stage investors.
Don’t be afraid to go into “offroad” territories, discussing issues
beyond the deal at hand: ask about the family, or discuss his
sports car parked outside. Take some time in the beginning to find
points in common; this will create a comfortable environment and
make a win-win negotiation easier to achieve.
- Be prepared, list your interests and understand the
desired term sheet. To illustrate the importance of
knowing your interests, my negotiation professor back at INSEAD
prepared a list of 76 points of interest beyond a typical salary
and bonus when negotiating his salary, when he first joined the
school. Those included insurance, housing, car, and his office. I
know that those kinds of requests might not be very reflective of
the entrepreneurial world we are discussing here, but the approach
is the same. Know your investment terms, list the key investment
requirements (don’t go up to 76! 5-15 should be enough) that you
would want in the term sheet. Those will be your interest points,
your negotiation arguments beyond the money and the equity. Yet in
doing this, remember not to get lost in the details and lose sight
of your goal – keep the big picture in mind.
- Maintain your discipline; watch out for the good
cop/bad cop routine. Almost all venture capital firms play
good cop/bad cop. Typically, the investment partner who invites you
to pitch plays the good cop role, whereas another industry
specialist plays the bad cop who is firmer with deal terms. The
important thing is to remember is to maintain your discipline.
Don’t get emotionally carried away, neither positively (when the
good cop takes your side) nor negatively under pressure. You will
be able to pinpoint the role play from the beginning; the difficult
part is to stay aware of it throughout the pitch and
- Be aware of being anchored. During preliminary
discussions and throughout the negotiation, investors might throw
out numbers on possible valuation of the venture. While some of
them might be in synch with your estimates, others might be just
for anchoring purposes. What do I mean by anchoring? If I tell you
now that a can of coke is typically sold for $5, assuming you don’t
really know the real price, and you go to a store and see it being
sold for $3, you will immediately believe it’s a good deal. But
maybe its normal price is less than $1 and you just overpaid by $2.
This trick of anchoring values has often been used by salesmen to
create the appearance of a good deal. The same happens with startup
investors. Some of them (not the ones that you would want to
conclude business with) would anchor you at a valuation that’s not
even close to normal conditions, and the best you can hope for is
to move +/-10% from that number. The best way to avoid anchoring
having a negative effect is to be aware of it, and take note if the
numbers seem a bit abnormal.If so and you still want to deal with
the same investors, I suggest you forget the valuation they are
proposing and suggest your own.
- Be flexible; don’t take a position too soon.
The key concept here is to keep the big picture in mind. Remember
that you are going to secure funds for your venture. This is not
about choosing your battles; we are still talking about a win-win
negotiation. It’s about making sure you keep your eyes on the end
goal and don’t dwell on small details might kill the deal. This is
not only about striking the deal with the investors, but also
showing your investors that you are a leader and you know what’s
important and what is not.
- Know your options- Don’t put all of your eggs in one
basket. Entering into a negotiation with an investor with
no other potential leads or bootstrapping options is like going to
war without a gun. Make sure you have other options, whether it is
friends and family funding, bootstrapping, other investors or even
just delaying the investment round. Know your options, study them
carefully, and if they are good, make sure the investor knows about
them (but don’t rub it in his or her face). Whether we like it or
not, investors are influenced by competition. Know your options; if
you don’t have one, find one!
- Be prepared to walk away. If you go in to a
deal without even considering walking away, then you are almost
guaranteed a less than optimal outcome. You might even decide to
bluff and pretend that you are ready to walk away. Remember that if
you are still sitting on the table, then you are still negotiating.
The only way to make sure you are credible is to actually stand up
and walk towards the door and don’t stop unless you are interrupted
by the investor. Bluffing by threatening to walk away is very
dangerous; don’t do it unless you are genuinely ready to leave the
room. Also investors like to see that you are confident about your
venture, and that you are ready to do whatever to see it work.
Using your BATNA (best alternative to a negotiated agreement) will
help your investors understand the minimum of what you will accept
before you walk away, as walking away too quickly might be to your
disadvantage on all fronts.
- Not all negotiations are closed on the spot.
It goes without saying that you will not get a response on the
spot. Negotiations will typically be carried on after a face to
face meeting through emails, phone calls… and so on. Don’t be
afraid to ask for clarifications or send clarifications as a follow
up to the meeting. But be careful of overdoing it, as it might
indicate impatience or a lack of other options. The best practice
would be to send an email after the meeting, and another one after
4-5 days if you haven’t heard anything from them.
- Last but least, don’t forget to hire a lawyer or have a lawyer friend go over the agreement. Some of the terms are usually beyond our lay understanding, but are standards to a lawyer. Never sign a term sheet before a lawyer goes over it.