Nivi · December 6th, 2007
“We took the approach of wanting to get to know the different partners and the different possibilities and to see where there was the best fit. Partnerships take a lot of work—you want to go out on a few dates before you get married. Yes, we dated a few people but didn’t get married… and so there were a few unhappy girlfriends out there. The choice wasn’t an economic choice, it was a customer choice.”
Summary: A deal is only as good as its best alternative. Keep improving your alternatives until you have a signed term sheet. And keep developing your current offers or they will die. Finally, don’t say “shopping around”, it puts investors off their stroke.
A reader asks:
“I have spoken to only one person regarding an investment, and they immediately said they would back my company. Should I contact more than one potential investor, i.e. shop around for someone who has experience in this space, and might be capable of injecting more capital for bigger goals? The product looks good, so I’m confident I can successfully engage other potential investors.”
In your mother’s womb, you learned that a chain is as strong as its weakest link. Now, in the awesome womb of Venture Hacks, you learn that,
A deal is as good as its best alternative.
Receiving a term sheet is a significant milestone. Receiving a verbal offer or an indication of interest is also a significant milestone.
But you should keep engaging alternative investors until you sign a term sheet. Sometimes, you should keep engaging alternative investors until you close (assuming the term sheet you signed doesn’t have a no-shop).
Improve your alternatives to get a better deal.
Create a market that is filled with alternative buyers. Without alternatives, you will be stuck in a hostage negotiation with a single prospective investor. With alternatives, you will do well. In Bargaining for Advantage, G. Richard Shell writes,
“Research has shown that, with leverage, even an average negotiator will do pretty well while, without leverage, only highly skilled bargainers achieve their goals.”
Spending time developing alternatives is as good as spending time developing your current offer. It increases the chances of closing your current offer. It closes your current offer faster. And it improves the terms of your current offer. Keep this in mind if you “don’t have time” to develop alternatives.
Develop your current offers or they will die.
Keep developing your current and pending term sheets while you engage alternative investors. If you sit on a term sheet for 2+ weeks, there’s a good chance, say 33%-50%, that the offer will disappear because the investor will move on to a shiny new company and his enthusiasm for your company will wane. Not to mention that most term sheets expire after a couple weeks.
Don’t let offers cool while while you warm up alternatives. Shopping around for Gucci underwear is effective as long as stores have it in stock. It’s not effective if each store runs out of inventory while you’re visiting its competitors.
The best way to keep investors warm is to focus on fund-raising so you can (1) get all your offers at once and (2) pick the best one before any of them cool down.
Buy a little time after your first offer.
When you receive your first offer, you can buy 1-2 weeks of time by saying,
“We’ve promised to close out conversations with a few investors and we need to honor our promise.”
“We’ve committed to a partner’s meeting next week and we need to honor our commitment.”
No investor is going to ask you to break your previous commitments. This little tactic buys you time and increases your social proof and scarcity.
You only need a few offers to clear the market.
How do you know if you’ve cleared the market? You need two or three offers from investors who make it a habit to invest in startups at your stage. These investors should create enough demand, social proof, and scarcity among themselves to improve your terms and clear the market.
Finally, receiving more than two or three offers means you will have to disappoint more investors. Turning down investors is surprisingly hard.
You’re not “shopping around”.
Finally, don’t use the words “shopping around” or “auction” with investors. Their reaction to these terms is,
“What am I, a bag of money? I can only get in this deal if I pay the most?”
You’re not “shopping around”, you’re “looking for the right partner”. While you’re talking to investors, you can define the right partner in terms of domain experience, or someone who wants to invest more/less money, or someone who has a history of backing the founders, or anything but: the guy who will pay the most.
Image Source: Visit Chandler.