And Implications for your Fundraising Pathway
For some founders, negotiating a seed investment can be difficult. For others, it can be a positive way to cement a long-term partnership with your investor. Most investors are not ‘out to get you’ and want to end up with a deal that is both aligned with your interests and will motivate you toward success. Without these two things, the investment is unlikely to return value to the investor.
The following highlights some ways founders sometimes trip up in negotiating an early investment round, resulting in a deal they are unhappy with, a tainted relationship with the investor, or losing the deal altogether.
Momentum is key. The single biggest killer of deals is a lack of momentum. Set a timeline and avoid letting the timeline slip out.
Keep your emotions at bay. Negotiations might be tense, but they should not be adversarial. If both parties cannot move through the negotiation constructively, it is not a good indication for how the relationship will track post investment.
Establish trust and maintain it. There are a lot of ways that trust can be eroded during a negotiation. One common challenge arises when founders are presenting their opportunity to multiple investors or are considering alternative financing strategies. Many term sheets have confidentiality clauses, so be cognizant of what you are disclosing to other potential investors about the specifics of your negotiations. Once deal terms have been agreed, you should not continue to shop the opportunity around.
Be transparent early about any ‘skeletons in the closet’. Most contracts will have a warranty clause in the settlement documentation, so make sure to raise any issues before settlement.
Have one team member as the primary communication channel. Investors will be watching closely how you manage this process as it is an excellent indicator of how your team will manage challenging decisions moving forward. This person should focus on ensuring clarity of communication and proactively mitigating misunderstandings.
Focus on the value of the deal, not just the valuation. Valuation is a common sticking point in investment negotiations, but other terms are likely to have far more impact down the road. Don’t forget the non-monetary value in the relationship with this investor and give that due weight.
Do not have extreme positions – you should not give it all away, but also don’t be too stubborn. Giving investors everything that they want sends the signal that either you are desperate, or you are incapable of managing difficult negotiations. Decide what you can and cannot accept – and don’t have too many non-negotiables.
Don’t die in a ditch. At the end of the day, a few percent here or there is not worth losing the deal over. Rank and order your priorities, compare this to the ranked and ordered priorities of the investor. Consider which terms you could ‘trade’ that are high value for the investor in order to get one of your non-negotiables agreed. Recognise where there are opportunities to find a middle ground.
When negotiating terms, keep them simple. Simple term sheets tend to have better alignment between founder and investor interests and are more likely to reach settlement. These terms should be appealing and easy for subsequent investors to understand and not create undue legal complexities that complicate later funding rounds.
Don’t bluff. Don’t say that you have done something, if you haven’t, and have data to back up your progress as it is likely that you will be asked to share this data to facilitate negotiations.
Appreciate some need for ‘downside protection.’ Investors are putting up money to back your vision. Even with extensive due diligence, at the end of the day it is because they are believing you and trusting the information you have shared with them. Many investors seek some level of ‘downside protection’ – meaning that if the opportunity didn’t materialise the way the founders projected it would (e.g. a down round or the company falls over), the investors have some special protection of their investment. The level of downside protections will range from quite reasonable to outright unfair. It is up to you to decide what level of protection you are comfortable with and to understand the repercussions for your shareholding now and into the future.
Negotiations can be intense. Consider having a mentor debrief with you after each negotiation interaction to reflect on what went well, what went poorly, and how to approach the next discussion.
Negotiating a seed investment is a substantial commitment of time and resources for all parties involved. When it is all said and done, if the negotiation was conducted well, whether deal terms were reached or not, all parties should offer a sincere thank you – whether that’s a note, a handshake, or a dinner.