Some people view any type of negotiation as a ‘zero-sum game’— anything you get is something you have to give. I much prefer and think it’s better to find win-win solutions, ones where everyone is on the same page about the considerations.
So once the investor is interested in investing, how do you structure the actual investment? How much of the company do you give him or her in exchange for their cash? It’s not an open and shut question to answer. Some people view any kind of negotiation as a so-called zero sum game—anything you get is something I have to give. I much prefer and think it’s better for everyone to try to find win/win solutions, ones where everyone is on the same page about the considerations involved in whatever negotiation is going on. I recommend a book called, Getting to Yes. That’s a wonderful treatise on how to negotiate win/win outcomes. But the real approach behind Getting to Yes, having win/win outcomes, is to be open [inaudible] about the various considerations that the counterparty has; to stop for a moment thinking about your considerations, and instead try to put yourself in the shoes of whoever you’re talking with, in this case the investor. What is it that they might care about? What are they looking for in terms of return? Ask them those questions. Many entrepreneurs will have a bottom line number that they’re not willing to go beyond. That’s perfectly fine, but does it make sense? What is that number based on? Is it simply based on what the perception of fairness is, what the market going rate is? That basis for a negotiation is fine and it’s typical, but it’s also not conducive to finding a win/win outcome. A much better approach in my view is to incorporate into the discussion what the anticipated return on the investor’s investment is. That means actually planning and plotting out what your financial needs are, what the anticipated exit is, and working backwards to an investment proposition. You might be surprised to discover that through no fault of your own, you’re actually proposing a terrible deal to the investor because your anticipated exit and the amount of money you’re raising means that there’s almost no way, even if you perform the plan you’re proposing, that they’re going to make any money. And it’s good for you to be up front about that if that’s actually the case. Because even if you’re able to get the money today, you’re laying the groundwork for a problem in the future.
More likely is if you actually did that plan, you would modify either the amount of money you’re raising now or the terms, and that means you’re more likely to get into a win/win scenario. Providing that kind of structure, the anticipation for what kind of exit you’re going to provide, is also a way for you and the investor to collaborate on what the inflection points are that you’re building towards, how you’re going to spend your cash, and what basically the business plan is. Again, it’s okay to change your plan; but by having that framework and that discussion early, you’re finding out something really important about your investor and vice versa, and you’re laying the precedence for that kind of communication. You’re then going to have a collaborative environment going forward; and what that means is that win, lose, or draw you’re going to be all on the same team.
Koss, Ann-Marie. “Best Practice Guidance for Angel Groups – Deal Structure and Negotiation.” Angel Capital Education Foundation. July 2007.
Berry, Tim. “5 Tips on Negotiating an Investment Deal.” Bplans. Article
Zwilling, Martin. “Don’t Let Investor Negotiations Kill Your Startup.” Forbes. Blog post. July 31, 2011.
Financing Your Venture: Venture Capital – Negotiating the Deal with Jeff Bussgang
Questions for You
What are the cares or considerations my investor might have?
What is the investor looking for in terms of returns on this deal?
What is my bottom-line number and what is it based on? Does it make sense in this instance?
What is my anticipated exit? Does this align with the investor’s thoughts?
Tools and Exercises
Researching an Angel or Angel Group: Talk to entrepreneurs the group or investor has worked with (successful and unsuccessful ones) to see how they behave in the good times and the bad. Find out what kind of end goal they usually try to attain in terms of company exit, leadership team, etc.
Own Your Venture – An equity simulator makes understanding the impact of raising money for an early stage venture transparent and easy to grasp.