Thirty-seventh 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.
I just brainstormed common pitfalls that entrepreneurs fall into during negotiations with my partner Richard Marsh. The top five are listed below, in rough order of importance/frequency of occurrence.
- Focusing on the wrong points/ignoring any of the most important terms
In previous posts I listed out the key terms in a termsheet (see here and here). A common mistake is to focus on other areas, either at the termsheet stage of negotiations or when the definitive documents are being agreed. There are a great many points that need to be discussed and many of them are complicated to understand and it can be easy to get excited about the wrong points. Wasting energy and goodwill on clauses of minor significance will weaken your position on other points and is a classic negotiating error.
- Trying to win every point
Trying to win every point makes sense in situations where there is no need for an ongoing relationship between the parties – for example when you come to exit your company. A VC deal marks the start of a relationship and is emphatically not one of those situations. So rather than to win every point the aim of negotiations should be to reach a deal that both sides feel is fair and reasonable. Fighting for every point will simply delay completion and get the relationship off on the wrong footing. It might also raise questions about your judgement.
- Having an inaccurate view of market norms
Most good VCs will be seeking to quickly agree a deal that is fair and reasonable (see 2) and their view of ‘fair and reasonable’ will be dictated by market norms which have evolved over time as the average outcome of previous negotiations. When there is a difference of opinion over what is ‘market’ then each side starts to think the other is being unfair, and things can turn acrimonious pretty quickly. This point really came home to me when I was negotiating a deal in 2006 and the company’s lawyer was arguing that liquidation preferences are unusual, we got stuck on this point for a long time before we managed to convince the CEO that we were being reasonable and his lawyer, a paid advisor, was in the wrong. (Note the importance of having advisors who are familiar with startup financings.)
It is possible to seek non-market terms, but in that case acknowledge that you are asking for something out of the ordinary.
- Allowing the negotiations to get deadlocked without understanding the underlying differences
Some negotiations fail because the two sides simply can’t agree on a deal, most commonly because of valuation. So long as that happens before two much time and money has been wasted then it is an inevitable occasional cost of doing business. However, some negotiations get deadlocked when a solution could have been found if both sides had worked harder to understand the underlying differences. Often this happens when discussions get overly focused on a single issue, egos come into play, and the wider perspective of the deal is lost. Much better to keep egos in check, keep asking why something is important (ask yourself as well), and then keep a few issues in play and be willing to trade.
- Taking your eye off the business
The process of raising money often takes 6-9 months and if momentum falters at any point during that period then the chances of completing a deal recede. The fundraising period is therefore doubly challenging because on top of the convincing someone to invest you need to keep the business moving forward with half your time suddenly taken away from operational matters.