10 Tips On Negotiating With VCs
So you have just finished months of grueling investor presentations and due diligence and finally one (or hopefully more) VCs have signaled their interest in negotiating the terms of an investment in your startup. This interest may be in the form of an actual term sheet that they’ve sent to you or a call/meeting/email indicating they would like to make an offer but want to talk about terms before shooting something over the transom.
First, congratulations, you are now in a *very* select group of startups. Having been on both sides of the table, here is my list of tips for entrepreneurs negotiating with VCs:
10. Relax. If you’ve gotten a VC to the table and they are negotiating terms, then the hook is set (they don’t [usually] do this lightly). It’s possible they could get away, but it’s not likely. Now you can focus on reeling them in…that’s something that takes time, focus and patience. There is no need to rush and from a negotiation point of view, you don’t want to seem too eager. So even if you are a few weeks from missing payroll, you want to come across as casual and as indifferent as your nerves will allow.
9. Start “reverse due diligence” now. I wrote a post on how to do this a while ago. There is real and perceived value in shifting the conversation away from “why should the VC invest in your company?” to “why should you take their money?” If you have more than one option, reverse diligence becomes even more important, but even in the scenario where there is only one offer you still want to make sure you’re not walking into an hornet’s nest. So if you haven’t started this already, get crackin’ now.
8. Use your attorney to help with thorny and low-level issues. You should be consulting with your attorney frequently during the process, and on certain issues you’ll want to use your attorney as an agent (who will talk to their attorney). This extra channel can be useful for low-level issues that come up in every deal as well as on particularly thorny issues. That said, don’t over-rely on this channel because at $800 per hour combined (remember you pay for both sides), legal fees can add up in a hurry.
7. Do your homework. Particularly if this is your first raise. Make sure you know as much about the terms you’ll be negotiating and their relative importance. Also, note that there is some subjectivity to this process so it’s worth building your own decision matrix. Read Venture Hacks. Go on TheFunded and check out all the actual term sheets they have there. Make sure you understand how the economics of a venture investment work such as liquidation preferences and dividends.
6. Be clear you are not the final authority. Even if you are, tell the VCs that someone else is the final decider. This technique is used quite often by car salesmen as well as VCs themselves. You know how they say, “let me talk to my partners” or “let me see what the boss says.” You can respond with things like, “I really want to work with you…can you give me something to work with on [some particular term] so that I can convince [my partners, board, other investors, etc.] to go with you?” At certain points in the negotiation (particularly near the end) you will want to avoid this so don’t over use it. As the deal solidifies you can offer (provided it’s true) things like, “I have authority to offer X, Y and Z. Can you accept that?”
Don’t over play this card because you also have to be careful to make sure that investors (your existing or the potential new ones) don’t go around you. In so far as possible, you want to keep your existing investors and potential investors from talking directly. This is sometimes hard to do, but it’s worth trying. It’s not just collusion that is a problem, it’s also can be confusing and risks blowing up a deal (or getting worse terms) if there are uncontrolled back channels.
5. Be honest. And be as forthright as possible. I know some will tell you that VCs are the “enemy” and they will screw you over at the flip of a hat so you shouldn’t have any compunction about returning the favor. There are some VCs out there like that, but certainly not all. I’ve had the pain and pleasure of working with both types and can report that honesty and candor is the way to go. For example, if this is your first time raising money, you should state up front that. Tell them that you will negotiate in good faith, but that it is possible (likely?) there are details you are not familiar with which you’ll have to come back and renegotiate and that you ask for patience in advance. I love that Scarface quote where Tony Montana says, “I never fucked anybody over in my life didn’t have it coming to them. You got that? All I have in this world is my balls and my word and I don’t break them for no one.” Not bad words to live by.
4. Negotiate by email, phone or face-to-face (in that order of preference).
I recommend negotiating by phone or ideally via email. In-person negotiations are tough. Remember that VCs negotiate terms on a weekly basis. They know these things inside and out. While you have to go “crank the spreadsheet” they intuitively know the results of a tweak to a term from comparison to other deals they’ve done or seen their partners do. Often times you won’t even know the meaning of a term and it hurts your position if you have to ask for an education. If you negotiate asynchronously you can always Google something or call an adviser. Also, if you’re doing a face-to-face that means you are limiting your negotiating options (hopefully you have multiple interested parties and you want to keep negotiating with them all simultaneously until the very end).
3. Control the documentation process. If there are multiple investors in the round, ask (demand?) that investors use one counsel. If they insist on having multiple investor counsels, you should tell them that you’re “only paying for one.” Besides the “two- or three-on-one” structure this also runs up the cost and consumes a lot more time. Most investors will agree to use the lead investor’s counsel and do any additional legal review by their own counsel on their own nickel and time. As a side note, I’ve noticed that the funds that use SBIC money have special issues that makes them want their own counsel. Since the SBA terminated this program this should be a less frequent issue, but in case you come across it I’d push back doubly hard (it’s not your problem they had to beg for government money!).
Another point to push for is to have company counsel prepare the first drafts of the documents. The documents these days are pretty standard, but I still believe that “facts on the ground” play a part in negotiation psychology. Unless you have particular leverage, you should instruct counsel to draft a “down the middle of the fairway” set of documents and this may help you in the margins.
2. Negotiate “complete” offers. Some people like to negotiate one term at a time and go back and re-open previously agreed terms while negotiating new ones. I personally find this style distasteful, although I’ve found it works well in a one-off transaction if you have the stomach for it (which I don’t). So instead of negotiating each term individually, ask for (and give) complete offers on all of the key terms. It’s a much easier and product method. If someone asks you how you feel about a “valuation of $15MM” the answer could be “great” if the other terms or reasonable or “that sucks” if not.
1. Get in a legitimate fight. At some point in the negotiation (ideally toward the end) pick a fight on some topic that you can make a real argument for. Don’t be rude, but be firm. The reason is two-fold. First, you want to test how your prospective partner argues; do they fight dirty, aggressive, passive aggressive or something else? Second, you want to leave them with the impression that you are an aggressive advocate for you, your shareholders and your business.
And since I can’t count, here’s a “bonus” tip:
0. Don’t say “no” say “not now” when turning down alternate investors. Even when you sign a term sheet (or close on a round for that matter) you still want to keep the alternate investors loosely engaged. You never know when you might need to re-engage them.
If you read this far, you must have an opinion…please do share!