Even in today’s hot venture capital market, startup fundraising is a tall feat. After jumping through the hoops of creating a pitch deck, getting introduced to investors, pitching to VC partnerships, and landing that coveted term sheet, there is still one crucial thing left to do: negotiate the terms of a deal.
Whether setting the terms for your company’s first priced round, or its final round of investment before an IPO, the negotiating techniques below will help you maximize the results of your fundraising efforts.
Focus on what matters
Before you start fundraising, meet with advisors and attorneys to identify which three to four items will be the most important to focus on during negotiations. Too many founders skip this step which can lead to severe and lasting issues. These items might include founder vesting terms, board structure, company valuation, founder ownership, founder secondaries, and option pool size as some of the primary concerns. By first identifying what actually matters for your company’s fundraise, you can more effectively maximize your negotiations.
For example, if you are raising a seed round and identify that maintaining your current board structure as the most important part of the fundraising round, you should approach only seed investors that don’t take board seats.
Furthermore, if you share these top priorities with your advisors before starting negotiations, they can provide better recommendations to optimize for those items. Also, by sharing these priorities with potential investors, the investors can then draft a term sheet based on your must-haves—or back out and not waste your time if their goals aren’t aligned with your priorities. Founders will frequently ask attorneys to review their term sheet and ask, “is this term sheet OK?” However, a skilled attorney should always respond with, “what do you truly care about?” A term sheet can contain hundreds of legal terms and complexities. By carefully selecting what matters most, a founder can avoid wasting careful negotiating leverage on terms that simply don’t matter as much.
Control the pace of your fundraise
Running a startup revolves around speed and maintaining strict discipline with project deadlines. Once a founder receives the first term sheet, however, founders should control the speed, or pace, of negotiations. Our recommendation is to slow down the process. Many successful venture capital firms simply do not move at the same speed of most startups. This is important to keep in mind when forming a negotiation strategy.
Your first investor will likely pressure you to sign the term sheet as fast as possible. They might present you with a term sheet and insist that it expires in 48 hours. In practice, however, this is almost never the case. This is simply a technique to “close” you on their term sheet as fast as possible. If a VC is excited to invest in your company on a Monday, chances are they’ll still want to invest in your company on the following Wednesday or Friday. Don’t be intimidated into signing a term sheet on a rushed timeline.
In practice, you should take enough time to create a “market” for your fundraise. You’ll want to promptly inform other interested investors when you’ve received a term sheet and determine if they’ll offer one up to compete with the other investor. Keep in mind, the terms of the deals and the identities of the investors is confidential, but the fact that you received a term sheet is not.
Rely on your advisors
Most mistakes that are made during fundraising negotiations can be easily avoided. Before you begin to reach out to investors, designate 2-3 experienced and existing investors, or advisors, as well as an experienced startup lawyer to act as your negotiations council. Keep this team in the loop whenever a new term sheet is received. Specifically, make sure you always review new provisions with this group as you receive updates to the original term sheet.
Secondly, you should carefully ask advisors the correct questions. Rather than simply asking, “Are there any red flags?” include questions like, “Is there anything I can do here to maximize my chances for success?” or simply, “Are there any other options?” By asking these questions, you can ensure that you totally understand all your negotiation options.
Create valuation leverage
The company’s valuation—or the valuation cap for convertible securities like SAFEs and convertible notes—is often the most complex part of fundraising negotiations. Often, founders ask early investors and attorneys, “What should my valuation be?” The answer to that question, frankly, is whatever valuation an investor is willing to agree to. The best method for creating leverage to negotiate your valuation with is creating a degree of demand in the market for your fundraise—which is achieved by maximizing the number of viable term sheets you receive from investors.
Attempting to request a higher valuation without additional term sheets is very difficult. Without a third party validating that higher valuation, you are simply trying to convince an investor that their valuation methodology is faulty or ignores a fundamental aspect of your company and its growth. Therefore, when creating your initial “funnel” of potential investors, you should include as many investors as possible. By maintaining a large funnel, you will increase the likelihood of obtaining multiple term sheets.
A founder can easily kill a potential deal by over-negotiating the terms of a term sheet. Over-negotiating might mean trying to fight over every small detail or maximizing for every negotiation point. Often, a founder will over-negotiate the key economic terms of the term sheet—valuation, round size, liquidation preference, or option pool size.
Be very careful and sensitive with these specific negotiating points as venture capital firms typically have less flexibility to negotiate on economic terms like valuation and round size. By carefully focusing on your top fundraising “must-haves” you will avoid over-negotiating and unnecessarily “killing the deal”. Also, think carefully about negotiating at all when you have only one term sheet—you have much less negotiating leverage to push back on terms in this situation.
Once you have maximized for the 3-4 most important points and have received feedback from your advisors, go ahead and close the deal.
Know when to walk away
Trust your instincts during the negotiating process. Unfortunately, there are venture capital investors that can ultimately harm, rather than help, with a company’s growth and development. Make sure to carefully vet any investors from founders that have previously or are currently working with not only the investment team but also the specific partner(s) you would be working closely with.
If advisors or attorneys are steering you away from working with a certain investment group, make sure to carefully consider those recommendations. Secondly, if the negotiation process with a certain venture firm goes unsmoothly, just remember that this can be telling of what it would like to actually work with the investors—you’re bringing people into the major decision making of your company who cannot be fired, so choose carefully. Recognize that walking away can often be the safest and best option. If one investor is interested in your company, there is almost always another firm that would also support your fundraising efforts as well.