Home > Financing Your Business
Negotiating Venture Capital Deals
You've done all the right things: hired senior management with industry experience, developed defensible intellectual property, have a product which will solve major problems in a billion dollar industry -- and you have your first paying customers. You come out of "stealth mode", officially ready to take the world by storm -- and the venture capital firms by surprise.
As you make progress in raising venture capital, you will get to the point of negotiating a venture firm's deal term sheet. Even though you may have seen one before, here are some tips on what to expect in the coming venture capital negotiations and how to frame your thoughts.
Depending on their stage of investment -- from early- to latter-stage -- venture capitalists are principally concerned with return on their investment. Almost every negotiating point in their term sheet will be aimed at increasing or protecting their chances for hitting the targeted return. (The earlier-stage investors can be a lot more like angel investors, looking for input in strategic decisions, holding one or more Board seats and having more timely or stringent reporting needs.)
So keep this thought in mind as you begin negotiations -- the most successful negotiations will always be where each party knows what they want and mutually reach agreement on how to achieve those goals.
Know The Target
It is highly unlikely that you would begin an out-of-town trip without knowing your end destination, right? Similarly, when you begin negotiating actual deal terms with a venture capitalist, one of the key points of information in your hands should be their targeted return.
Once you have a sense of the target, evalaute each important deal term in light of the target. Use your own projections to get a sense of what is reasonable and what may be overkill. Alternately, simply ask the VC how they used your numbers to calculate the market value of your company and to share their calculations with you. If you get a sense of unreasonableness or unwillingness to share valuation information, strongly consider moving on to the next firm -- assuming there is one.
Control vs. $
In most entreprenuerial negotiations there is a certain amount of give-and-take between control issues and money. The key to negotiating and later working with venture capital investors is to remember that they are return-driven. They simply are not interested in running your business! The closest most firms get to the control issue will be Board representation and certain downside protections if the business is not doing well.
One caveat - if you are also seeking significant financial reward, don't start applauding because that puts you on the same page as the investors. The difference will be that their preferred stock or other such security will allow them first dibs on any reward! Any returns for you and your earlier stage investors will come later.
Time Is A Key Factor
Unless you are looking to cash out in a few years, which is a pretty unrealistic goal, you are in this business for the long haul. That gives you plenty of time to achieve the kind of financial success you are looking for. But beware, your capital investors, no matter their stage of investment, should know your goals and plans in this regard. You can be fairly certain that they are interested in one or more liquidity events that let them meet or exceed their return targets. Be responsive to this, because you should all be on the same page as far as timing is concerned.
Deal Terms You Will See
As you view any term sheet, you will see items such as preferred stock or demand notes, Board representation, a host of reporting and performance covenants and then a long list dealing with items such as management compensation, stock option plans and the like. Try to deal with each item using the strategic analystical framework : they are only in it for the return!