Negotiation techniques are crucial for entrepreneurs seeking investment. From understanding key financial terms to mastering employee and governance provisions, these skills can make or break a deal. Knowing your BATNA, creating win-win solutions, and identifying deal breakers are essential strategies.
Effective negotiation helps entrepreneurs secure favorable terms while building strong relationships with investors. By mastering these techniques, founders can protect their interests, align incentives, and set the stage for successful partnerships that drive growth and value creation.
Key Financial Terms
Term Sheets and Valuation
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Term sheet is a non-binding agreement that outlines the key terms and conditions of an investment deal between a startup company and an investor
Valuation refers to the estimated worth of a company, which can be determined through various methods such as discounted cash flow analysis, comparable company analysis, or precedent transactions
Pre-money valuation is the value of a company prior to receiving investment, while post-money valuation includes the investment amount (pre-money valuation + investment amount)
Higher valuations can lead to larger investments but also greater dilution for existing shareholders (founders, early investors)
Equity and Dilution
Equity represents ownership in a company, typically in the form of shares or stock options
Investors receive equity in exchange for their investment, granting them a percentage of ownership and potential future returns
Dilution occurs when a company issues new shares, reducing the ownership percentage of existing shareholders
Anti-dilution provisions can protect investors from excessive dilution in future financing rounds by adjusting the conversion price of their preferred shares (full ratchet, weighted average)
Liquidation Preferences
Liquidation preferences determine the order and amount of payout to investors in the event of a liquidation event (acquisition, merger, or dissolution of the company)
Preferred shareholders typically receive their investment back first, before common shareholders, and may also receive a multiple of their original investment (1X, 2X)
Participating preferred allows investors to receive their liquidation preference and then participate in the remaining proceeds alongside common shareholders
Non-participating preferred gives investors the choice between receiving their liquidation preference or converting their shares to common stock and participating in the proceeds
Employee and Governance Provisions
Vesting Schedules
Vesting schedules determine when and how employees or founders earn their equity over time, incentivizing them to stay with the company and contribute to its success
Typical vesting schedules span 3-4 years, with a one-year cliff (no vesting until the first anniversary) followed by monthly or quarterly vesting
Accelerated vesting can occur in certain events, such as a change of control (acquisition) or termination without cause, allowing employees to receive a portion or all of their unvested equity
Vesting provisions help align the interests of employees and founders with those of the company and investors
Board Seats and Governance
Board seats represent positions on the company's board of directors, which is responsible for strategic decision-making and oversight
Investors often require one or more board seats as a condition of their investment to ensure their interests are represented and to provide guidance to the company
Board composition can include a mix of founders, investors, and independent directors with relevant expertise
Voting rights and protective provisions can give investors additional control over key decisions, such as issuing new shares, acquiring or selling assets, or changing the company's bylaws
Negotiation Strategies
BATNA and Reservation Price
BATNA (Best Alternative to a Negotiated Agreement) is the most advantageous alternative course of action a party can take if negotiations fail
Knowing your BATNA helps determine your reservation price, which is the least favorable point at which you are willing to accept a deal
Entrepreneurs should identify their BATNA and reservation price before entering negotiations to avoid accepting unfavorable terms or walking away from a good deal
Having a strong BATNA can increase your negotiating power and help you secure better terms (alternative investors, revenue growth, partnerships)
Win-Win Solutions and Value Creation
Win-win solutions aim to create value for both parties in a negotiation, rather than one party gaining at the expense of the other
Entrepreneurs should focus on understanding the interests and priorities of investors, not just their positions, to find mutually beneficial outcomes
Value creation can involve expanding the pie (increasing the total value to be divided) through creative problem-solving, such as offering strategic partnerships, access to networks, or complementary resources
Collaborative negotiation strategies, such as principled negotiation or integrative bargaining, can help parties find win-win solutions and build long-term relationships
Deal Breakers and Walking Away
Deal breakers are issues that, if not resolved satisfactorily, would cause a party to walk away from the negotiation
Entrepreneurs should identify their deal breakers before entering negotiations and communicate them clearly to investors to avoid wasting time on unacceptable terms
Common deal breakers for entrepreneurs may include giving up too much control, unfavorable liquidation preferences, or insufficient investment amounts
Walking away from a deal that does not meet your minimum requirements is sometimes necessary to protect the long-term interests of your company and maintain your BATNA