How do we negotiate a deal with investors?
Discussions about At the Closing Table and Beyond
Congratulations! Out of a thousand plans, maybe 100 or so get considered and only about twenty get to meeting—so you are on your way! As you get into the talking points of a deal, know that there is much you can control when negotiating with venture capitalists. In fact, far more is negotiable than you may think, it only depends on your negotiation skills and tactics.
According to Richard Siegelman, general partner at Kleiner Perkins: “A venture capitalist makes three decisions. First, to invest and how much. Second and third, with the rest of the board, to hire and fire a CEO. Everything else is cajoling, persuading, and presenting evidence.”
Intelligent negotiators are prepared, confident, and supremely effective. Herb Cohen, the author of You Can Negotiate Anything, defines negotiation as “a field of knowledge and endeavor that focuses on gaining the favor of people from whom we want things.” Effective negotiators use information and power to affect behavior.
Leigh Steinberg is a premier sports agent, and the movie “Jerry McGuire” is based on his success. He has negotiated more than $1 billion in salaries and bonuses. In Winning with Integrity, his guide to negotiation, he states, “Effective negotiation is about exhaustive preparation, utter clarity, heartfelt communication, and a sincere, demonstrated desire to fully understand not just your own needs but the needs of the other party.”
The negotiating techniques you select for your meeting with the investors will depend upon the particular situation, your personality, and the relative strengths on both sides of the closing table. But the ground you will inevitably cover includes stock restrictions, debt conversion, dilution protection, vesting, your ongoing commitment to the venture, downstream liquidity, directors, and price per share.
The typical end product of this first round of negotiation is the term sheet that the venture capitalist prepares and presents to entrepreneurs. It specifies the key financial and legal terms of the investment and serves as a basis for the negotiation and preparation of the definitive legal documentation. The legal specialists that are working for your team should be very familiar with the many terms and restrictions that are typically found in such term sheets for investors.
Watch Out for Sand Traps, Land Mines, and Deal Killers
Imagine an inexperienced golfer, swinging and swinging away at a ball in a sand trap. Well, most venture capitalists will allow you to tee-up the ball and watch you take a swing. If you happen to land in a sand trap it demonstrates your competency (or really lack of) in the venture drill process. Missing some details, forgetting names and conversations from your last talks, is all part of the process. You will get a lot of room for making simple errors because they know that you are going into unknown territory.
Land mines, however, are a different story. Thomas Fuller, the English historian, once said, “Get the facts right, or the facts will get you.” There are two types of land mines: an explosive that you will eventually stumble across, and an explosive that VCs will eventually stumble across. Venture capitalists evaluate business plans and presentations for a living. Remember everything you have said along the way because they will.
And be very careful about what is projected or promised in your talks. Consider the fact that you will be held accountable for your projections and promises. Any deception in a plan or presentation will be caught right away and greatly lessens the possibility of an investment. Worse yet, having the VC step on a landmine in the due diligence process (something that should have been disclosed earlier) will probably permanently “disfigure” the deal and maybe damage some on the venture team as well.
Finally, there is the deal killer. Just like it sounds, it is something that will kill the deal instantly for that particular investor. Triggering any one of the deal killers can be quite costly for you, especially when there is a limited number of venture firms you can approach.
The objective is to obtain legal documents acceptable to the venture capitalists’ legal team and to your venture team. But just this one step can seem to go on endlessly, as the legal drafts will get ping-ponged back and forth between the two teams of lawyers. As soon as a consensus is reached, you and the investors can sign the closing documents, and at that point you will get your check.
Your role is to manage the process by being in touch with your lawyer, the VCs, their lawyers, and putting together all the required documents from your side. When problems arise you should be prepared to quickly be a part of the solution in order to keep the closing going.
Finally, going to the VC’s office to sign the legal documents and pick up the check is a very exciting moment for everyone involved. It will be very hectic and busy, so bring only the officers required to sign documents for your venture and your legal team. You will have to wade through piles of documents, and expect to sign your name no less than 100 times.
Depending on where you are on the entrepreneurial life cycle discussed in the Introduction, and on how quickly you can learn, the average time from when you start your fund-raising process till you get a check from the venture capitalists will be about nine to eighteen months. You will need about three to nine months for preparing your business plan and for early attempts at placing it. Then plan for another six to nine months once you have had your initial meetings with a venture capitalist. They need time to perform the due diligence, and most likely, they need time to put together a syndicated deal.
Beyond the Closing Table: Delivering the Value You Promised
You first objective after the closing should be to go out and build that great venture you promised. The last thing we want you to do is to be managed and controlled by fear. But you do need to understand this plain and simple cold-hard fact: You are dealing with professional investors. You will get only one chance to lead your venture to success. After the closing, your investors will be very busy managing other deals and portfolio companies. So it will be your responsibility to keep them informed about your business.
You will be expected to communicate and work with your investors on a regular basis for the next two to seven years. Most VCs would prefer being e-mailed and called on a weekly basis, and most investment agreements will require you to submit monthly financial statements. VCs believe that no venture can be properly managed without accurate, timely, monthly financial statements. Be forewarned that to them, tardy and/or poorly prepared financials are red flags that most likely indicate a revenue crisis on the horizon.
Finally, expect to have quarterly board meetings at your location. You should be well prepared for these meetings. There should be an agenda, complete briefing books, and formal presentations, followed by walk-throughs to meet with key employees.
Success comes to those who can form trusting relationships with their investors. Look at your investors as your best friends in the business world. On this matter, our best advice is for you to follow what Samuel Johnson once said, “There can be no friendship without confidence, and no confidence without integrity.”