50 Questions: How should an entrepreneur approach negotiation of the key terms?

Thirty-sixth in a series of weekly posts by myself and Nicholas Lovell of Gamesbrief which answer the fifty questions you should ask before raising venture capital.  We expect the series to run for a year after which we will collate the posts into a book.  You can find the rationale behind the series here, and the list of questions here.  We welcome your comments on any and every aspect of what we are doing.

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My last post in the 50 Questions series was a mathematically dense explanation of how anti-dilution clauses work.  This week I’m relieved to be back writing prose!

The most important term in the termsheet is without doubt the valuation.  My advice here is to follow standard practice and let the VC be the first one to come up with a number.  Letting the other side go first is text book best practice for negotiations – you never know, but you might just get a higher valuation than you were expecting.  Most VCs will press hard for some kind of indication prior to putting in an offer, and if you feel you have a good handle on market rates for your type of company then giving an indicative range can help the process along, but I would avoid giving a precise figure. 

Advisors have the best feel for market rates and when they are leading a deal it is common practice to guide investors with a valuation range.  It is much less common in deals without advisors and I think that is because in these situations the board is less confident that they will get the range at the right level.

In some situations there is a genuine floor beneath which the current shareholders aren’t willing to take an investment.  In that case it is worth telling prospective investors as soon as they get serious.

Beyond valuation my advice is to stick pretty closely to standard market practice.  If the termsheet being offered is plain vanilla (i.e. 1x participating preference share, weighted average anti-dilution, standard consent rights) then the best approach is to agree it pretty quickly and focus on getting to completion.  If a VC starts out with standard terms it is likely because they want to do a quick and fair deal, and trying to move the terms from fair to entrepreneur friendly probably won’t work.  If, on the other hand, the termsheet is full of non-standard clauses that advantage the investor then I would work hard to get the deal back to market norms.

The third and final point is that if there is anything non-standard that is important then you should get that on the table early.  I would avoid being aggressive, but at the point when the investor starts talking about issuing a termsheet it is worth saying something along the lines of ‘one of the things we would really like to see is XYZ’.  Then (if she is so inclined) the investor can build your request into her models early and hard to change expectations won’t get set in the wrong place.

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