Nivi · June 19th, 2011
“Every time the other party says ‘I want’ in a negotiation, you should hear the pleasant sound of a weight dropping on your side of the leverage scales.”
Most entrepreneurs don’t understand the power of positive leverage. Here’s a typical situation:
After weeks of fund-raising, you find a brave investor who says “Yes, I want to invest.” He says he will give you an offer soon. You’re excited. A few days later he delivers a term sheet that you don’t like. The valuation is really low. Or the non-economic terms aren’t favorable. Your excitement turns to disappointment and frustration. This is the only offer you have so far. What do you do?
First, we hope you’ve been talking to several investors at the same time and creating a market for your shares. With an adroit touch, you can use this first offer to create the scarcity and social proof that drives other investors to say “yes”. At a minimum, you can use this offer to drive investors to make any decision at all — up or down. And keep improving your alternatives until you’ve a signed term sheet.
But let’s assume you don’t have any other offers and you have to negotiate with this investor. Or that this investor is your first choice — whether or not you have alternatives.
Positive leverage
This type of negotiation is similar to a hostage negotiation because you can’t walk away from your opponent. You can’t say, “Yeah, it’s okay, go ahead and kill the hostages, we’re not interested in your demands.”
When you have to negotiate without good alternatives, the tools of positive, negative, and normative leverage are essential. Positive leverage is your ability to provide things that your opponent wants. You have positive leverage when your opponent says, “I want to buy your car”, “I want you to release my friends from jail” or “I want to buy your shares”.
As soon as your opponent says he wants something from you, you have some positive leverage. You control what they want. You can grant them access or deny it. That’s why experienced opponents delay making offers — they don’t want to give you leverage.
In practice
How does positive leverage work in practice?
First, positive leverage should improve your psychology during the negotiation. You’ve gone from a situation where you want something from the investor to a situation where you both want something from each other. Your psychology is critical in a negotiation because “leverage often flows to the party that exerts the greatest control over and appears most comfortable with the present situation.”
Second, you can now identify other things that your opponent wants and deliver them. Maybe you’re working with a partner who is trying to get his first deal done at the firm. Help him succeed and help yourself in the process. Maybe you’re working with a firm who is excited about stealing a deal from a top-tier firm. Help them succeed. Maybe you’re working with a firm who wants to co-invest with a top-tier firm so they can show off to their LPs. Help them succeed.
Third, even before investors makes an offer, you gain a little bit of leverage every time they ask for something. Don’t try to use it after the first meeting. But if you’ve been talking to them for three weeks and they’re getting deeper and deeper into diligence, you should recognize and use your leverage. At a minimum, you should ask for information about their process and thinking at every step of the way.
The prime time to negotiate is when your opponent says, “I want.”
“If they’re talking to you, you have leverage.”
Topics Negotiation
Solid post, Nivi. As a corporate lawyer for 17+ years, I can attest to the hard truth that it takes many years to develop strong negotiating skills. That’s why entrepreneurs (particularly first-time entrepreneurs) are at such a disadvantage negotiating with investors. Think about: an investor in the VC business for 15 years has likely negotiated 50-100 deals. How many deals has the first-time entrepreneur negotiated?
Don’t misunderstand me – guys like you and Naval are so important to entrepreneurs, and your posts and advice are extremely helpful; however, like most things in life, it’s only by actually doing – by experiencing — that you can develop a strong skill set. That’s why it’s important for entrepreneurs to have an experienced advisor and/or lawyer to help them and coach them.
Keep up the great work.
Cheers,
Scott (@ScottEdWalker)
I think it is good to discuss the negotiating options for entrepreneurs, especially first-time entrepreneurs. However, one thing to keep in mind is that the leverage they have in reality is very small. There are many more companies looking for money than there are investors.
A typical VC looks at something like 10 deals every WEEK and hopes to be a partner on TWO or THREE deals a YEAR. That’s 500 companies considered vs. 2 invested.
Negotiate, yes, but, by all means do not overdo it. A VC will walk away from a deal if he feels that a funding round (especially an early funding round) is too difficult to negotiate and there is too much haggling. It’s a first financing, not an acquisition. You will have to live with each other for the next 5 to 7 years.
Remember, the company usually wants the deal a lot more than the VC. And, unless you have equivalent firms ready to not just step in but accept the conditions over which you are willing to cut off negotiation, you might not get a deal done at all. Also keep in mind that, usually, VC’s terms, even from different firms, are approximately in the same ballpark. And, if one group found something difficult, so will another.
Some (detailed) examples would be really awesome here, Nivi. Not from hostage negotiations. For that we can read (and I did) “Bargaining for Advantage”. Everything else would be fine to motivate our creativity in such a situation. For example from your experiences with an and as Investor. Also other situations like a parent trying to make their children eat vegetables and so on.
You can’t just say “Well, now you want something from me. I am unhappy, now do whatever I want.”
@Scott: I think your argument should not be treated as a “But”, because the other way around you’ve got the same problem. If you have a lot of experience but nearly no theoretical knowledge you will be for sure better then a novice but far, far away from the best of your skills. So for example a well educated but unexperienced university student who tries to make his weekend project big, might actually have a real advantage over a 10 years experienced Angel who never learned anything about bargaining but from his experience.
I hope I can show why theoretical knowledge actually is highly valuable, experience or not. Another situation where I think theoretical knowledge might provide value even without experience:
Often you learn a lot more from each experience if you know better what to look for, how to interpret the reactions on the bargaining table and how to evaluate the quality of your result. From my own experience I know for example, that expert bargainers can make you actually feel good about making a really bad deal (for you, not for them), if you don’t know what they are doing or that they actually would try that. And thus without education your experience even might reinforce you in the wrong direction.
I was a year in China, where I could experience a lot more bargaining situations in every day life. People there try to trick you for every cent if they can. I think I learned a lot there, which I hadn’t if I never read anything here on venturehacks (when I started reading here I was as wet as pure water).
Thanks for the good post, Nivi. All we often need is encouragement and a quick tip. At its core, any negotiation is about perceived value and leverage. How much of these we intrinsically have and how much we create is a matter of situation and skill but deals happen only when both parties perceive they have exchanged value.
I tend to disagree with Kirill that a VC has more leverage by default. The fact that a VC looks at hundreds of companies per year changes little the VC’s leverage in a negotiation with a company they want to invest in. A VC offers terms and negotiates with very few of these hundreds of companies and for a reason. If a VC is offering to you, this is a clear indication they see value. As Nivi mentioned, there may be nuances as to why they see value. I will add my five cents here. Don’t make quick assumptions. Rather, make your best effort to understand what the VC values most in this transaction. This will not only improve your chances for closing a good deal but making it a win-win one. After all you will be partners for years to come.
Great post! First Term Sheet I ever did was along these lines – and I learned a lot about positive leverage from that experience (although I did not know of the that precise term at the time). There is also a situational fluency to every deal, that’s hard to capture/teach – especially as a first time experience. This post should help calm those fears – and nerves – as they will be evident.
:dm
Thank for the great knowledge sharing… I’ve read some time ago a wonderful book about hostage negotiation (Hostage at the table, by George Kohlrieser – http://www.hostageatthetable.com/): a must-read for entrepreneurs, and not just to raise money, but also to efficiently deal with every aspect of professional (and private!) life!
links for 2011-06-22 | inluminent // Jun 22, 2011 at 10:01 am
[…] Getting Leverage in Hostage Negotiations – Venture Hacks (tags: business startup entrepreneurship startups investing) […]
This is great advice that I could use in conjunction with using a win-win scenario. Being able to have a trigger such as “I want” is invaluable as now I know where I have something that is worth negotiating from they point of view.
Nivi,
This is useful information for entrepreneurs who are new to this type of business deal or serious negotiations.
Really, leverage is such a small part of a negotiation. It can easily be used as a tactic by either side to confuse or distract. So you shouldn’t spend too much time focusing on it.
It’s better to view negotiation as a dance. One party moves and then the other one moves. Sometimes the moves don’t follow the same tempo, so you have to step away and determine whether coming back together to finish the dance is the right move or not. Based on the first offer and first counteroffer you can normally predict (to a surprisingly accurate range) where the price and terms will end up if an agreement is reached.
It’s important to go into any negotiation already knowing what your BATNA (Best Alternative to a Negotiated Agreement) and WATNA (Worst Alternative to a Negotiated Agreement) are, whether the other side prefers or typically uses an integrative or distributive style in negotiations and how much time you and the other party are willing to invest in the process.
Culture, Gender and Age of the parties are also other important factors to consider in a negotiation. This can help you figure out how both you and the other party view perceived power distance issues, the rules of the negotiations, how/when/where the negotiations are to occur, appropriate language to use or even language barriers you may face.
I tend to get concerned when someone says you need to wait for an offer from the other party first. You’re giving up a lot of power in the outcome by doing this. Although in some cases you have to wait for an offer, it’s very important that you find a way to create a price “anchor” in the mind of the other party first. You’ll find that by being the first person to make an offer (even if just as a hypothetical during conversation) it will give you a better position in the end.
You have to be willing to adapt to different styles and issues in negotiations, otherwise you will likely come out severely disappointed and unhappy with the outcome.
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[…] Jim Riggleman Can Teach Us About Negotiating Posted on June 27, 2011 by TechonomicMan Last week’s post at VentureHacks on negotiating terms in a capital raising effort provided an excellent context for evaluating the […]
Nivi, you post was cited in a Negotiations forum which I responded to so copying in my comments below on your very useful post:
‘As a former crisis negotiator I was interested when you first posted the subject. I suppose one of the key messages that emerged from the article related to the ‘power of dependence’ – and this concept of power can be seen in concepts such as BATNAs & WATNAs – I often refer to the power of least dependence as it relates to negotiation theory – in simplistic terms we can see this in strengthening our BATNA and weakening the other parties BATNA. True engagement of the other party in integrative negotiation relies upon your ability to build their sense of dependence upon (and trust in) you to help them develop the best options/solutions to their problem.’