Venture capital is an invaluable resource for the nascent business. Providing much-needed capital, VCs enable a business to fund the future growth that every entrepreneur hopes for. Negotiations between entrepreneurs and VCs frequently allow a company not only to raise funds but also to create long-term value through lasting business relationships. However, these negotiations also present risks to the inexperienced entrepreneur. By focusing on the right negotiation strategies, entrepreneurs can avoid the temptation to either give up too much in exchange for too little or overreach and potentially jeopardize important relationships.
Few business negotiations involve the degree of emotion, uncertainty, and high stakes present when company founders negotiate with venture capitalists.1 Part of the negotiation process is about reaching an agreement on important elements found in the term sheet – how much control and equity a VC will receive in return for its investment. But these negotiations are also about developing long-term relationships that will stand the test of time, enduring both the disappointments and successes to come.2
The most important negotiations often involve the company’s valuation.3 The company’s founders will first determine value through earnings projections, and they will submit this valuation to VCs. The next valuation comes from the VCs and will likely be substantially lower than the founders’ estimate. As a result, startups are often advised to inflate their valuation to secure the actual amount of financing desired.4 Besides valuation, control is the other primary concern for a company’s founders. Entrepreneurs are often reluctant to give away control of something they’ve created, but at the same time, VCs are unlikely to invest without some future decision-making ability.5
It is obvious that the interests of founders and VCs are frequently at odds, given their divergent objectives. After all, both parties want the best deal for themselves. It is perfectly fine for a VC to offer whatever it wants, even if the offer seems low; likewise, there is nothing wrong with a company turning an offer down if the terms aren’t acceptable.6 Where entrepreneurs run into trouble is when they convince themselves that they only have one option. In doing so, they compromise their ability to negotiate for a better deal when they believe the one before them is the only one they will have.7 A valuable lesson for entrepreneurs in negotiating with VCs is that you can always say “no.”8 In negotiations, there are always other options, and maintaining the ability to say “no” is important. The idea behind that is what’s known as a BATNA – your “best alternative to a negotiated agreement.”9 But besides walking away from an offer, what else can entrepreneurs do to avoid a bad deal? First, understand term sheets and what goes into them. Second, be able to see what VCs want, from their perspective. Third, utilize an attorney experienced in these types of deals. And lastly, know the point past which you won’t compromise on important issues.10
Another common mistake entrepreneurs make is to discount the nonmonetary resources a VC firm can bring to the table.11 In fact, VCs can contribute much more than just money, including mentoring, strategic advice, and access to their networks. But by trying squeeze out the highest valuation, entrepreneurs run the risk of ignoring these value-added services and focusing only on money. This can leave a bad taste in the VC’s mouth, and it may be unwilling to share the benefit of any additional assistance in the future.12
By focusing on long-term strategic partnerships and the ability to view VC deals from both sides of the table, entrepreneurs will be better equipped to not only raise capital but also create lasting value for their companies.
Deepak Malhotra, How to Negotiate with VCs, Harv. Bus. Rev., May 2013, at 84, 84. ↩
Id. at 84, 86. ↩
Bryan Springmeyer, Negotiating Venture Capital Transactions, Springmeyer Reddy, http://www.calstartuplawfirm.com/business-lawyer-blog/venture-capital-negotiations.php (last visited Oct. 4, 2013). ↩
Erik Sherman, Most Important Rule in VC Negotiations, Inc. (Sept. 13, 2012), http://www.inc.com/erik-sherman/most-important-rule-vc-negotiations.html. ↩
Malhotra, supra note 1. ↩
See id. ↩
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