Negotiation Posts

How many similarities can you find between hacking fund-raising and hacking a car purchase? Watch this video:

The best answer gets a coveted Venture Hacks mug.

(Via Lifehacker.)

dharmesh.jpgDharmesh Shah recently wrote a very nice review of Venture Hacks. The article includes great meta-advice about fund raising:

1. VC Negotiation Is An Art Form: As an entrepreneur, there are few things more “nuanced” that you’ll deal with than raising institutional capital. Even if you decide not to raise venture capital, a lot of these skills and deal-terms will likely show up in other dealings you have (strategic partners, M&A transactions, etc.).

2. The Devil’s In The Details: Most entrepreneurs focus too much energy on the “obvious” things like valuation. Fact is, there are other, non-valuation terms in the VC deal (vesting, stock option pool, liquidity preferences, etc.) that have a significant impact on the economics of your deal. It’s easy to lure yourself into thinking you should solve for the highest valuation. But, in most cases, that’s sub-optimal.”

I would go even further: non-valuation terms are more important than valuation. Valuation is temporary, control is forever. If you don’t control your future, your current valuation is irrelevant.

Your current valuation is irrelevant if you are terminated and you lose all your unvested stock. Your current valuation is irrelevant if the board forces the company to raise a low-valuation Series B from existing investors by rejecting offers until the company is almost out of cash.

3. Great Advice Is Hard To Find: As it turns out, good advice in the VC business is hard to find. I would define good advice as a combination of competency (i.e. well informed) and objective (i.e. non-conflicted). You can get close sometimes (via lawyers, advisors, etc.) but it’s really hard to find great advice.”

The amount of advice on entrepreneurship on the Web is exploding. Some of it rocks. Some of it sucks. Advice is only as good as its source. Our source is me and Naval—we’re trying not to suck.

4. It’s Not Enough To Be Smart: It’s important to remember that regardless of how smart you are, VC negotiation is not just a matter of raw intelligence. Sure, it helps to have a few brain cells to understand the dynamics of a deal, but a lot is hidden away in the dark corners that you only ever learn by doing it. It’s also important to remember that the VCs do this for a living. Hopefully, you don’t (you’re building businesses for a living). You may be twice as smart as they are, but you’re still at a disadvantage. Try to even the playing field as much as you can.”

Dharmesh’s site, On Startups, is a great resource for entrepreneurs.

“Having information that the other side doesn’t have gives [VCs] an advantage… they take advantage of entrepreneurs who haven’t been through this before… they were totally willing to take advantage of us.”

Mitch Kapor, Founders at Work

“Knowledge is Power.”

Sir Francis Bacon

In this series of articles, we’re going to explain how to negotiate a great deal with your Series A investors. We’re calling this series Term Sheet Hacks.

The VCs know more than you do.

You, the entrepreneur, negotiate a term sheet once every few years. You negotiate your most important term sheet (the Series A) when you have the least experience. You negotiate against a VC firm that issues two to three term sheets per month. You negotiate against a “standard” term sheet that encapsulates decades of combined knowledge from hundreds of venture firms.

Like a good chess player, your prospective investors know what the game looks like many moves from now:

  • Their term sheet foresees the Series B, possibly terminating you, selling the company, and more.
  • Their term sheet anticipates those events and includes terms like ‘protective provisions’ and ‘election of directors’ that create the best future outcome for their firm.
  • They employ a full-time CFO or general counsel who ensures their firm is cutting good deals. And his shelf is filled with books on the hilarious topic of term sheets.

On the other hand, you probably have a basic understanding of a few simple terms like ‘valuation’ and ‘vesting schedules’. You barely know what the game looks like right now, let alone at the Series C.

Your investors can take their time – they have years to invest their money – but you’re under pressure from your employees and co-founders to deliver the money that will keep your company alive. The clock is ticking…

Good companies get bad deals all the time.

Many of the successful companies that we all read about in the news didn’t negotiate good deals simply because they didn’t get good advice. Consider Jim Clark‘s (founder of SGI and Netscape) account in The New New Thing:

“At [SGI] board meetings… Jim’s face would get red and he’d start shouting that [an investor and board member] had cheated him and his engineers.”

Or ask a friend who has taken money from investors.

Whether these stories are true is irrelevant. Like any negotiator, your prospective investors are not in the business of giving you a good deal. They are in the business of making money for themselves and their investors (their limited partners).

Isn’t this what my lawyers are for?

In principle: yes. In practice: no.

With few exceptions, most law firms advise their clients to accept “standard” terms.

Most law firms do a lot more business with VCs than they are likely to do with you. VCs refer new clients to the law firms, hire the law firms regularly, and know the attorneys socially. Where do you think the law firms’ loyalty lies?

The basic incentives between you, your law firm, and your prospective investors are not in your favor. Your lawyers make money by executing transactions and your investors simply bring more transactions to your lawyers than you do.

You can’t hack a term sheet without leverage.

Don’t bother trying to apply any of these term sheet hacks if you don’t have leverage. You can’t negotiate at all without leverage. Roughly speaking, leverage is power.

Alternatives are the most basic type of leverage in any negotiation. Fancy negotiators call their best alternative a BATNA (Best Alternative To a Negotiated Agreement). If you’re negotiating a term sheet with the famous Blue Shirt Capital, your BATNA may be an independent term sheet from the renegade Herd Mentality Management.

A BATNA is just one type of leverage and it is possible to negotiate effectively without a good BATNA. Hostage negotiators do it all the time. But if you’re not in the mood for a hostage negotiation, get multiple offers before you apply any of these hacks. Don’t let anyone tell you that creating competition to invest in your business is a bad thing.

Let’s get this party started.

Our goal here is to give you the knowledge to effectively negotiate against the experts. We don’t have all the answers but we’ve negotiated enough term sheets, started enough companies, and learned from enough entrepreneurs, lawyers, and VCs to understand how this game can play out. Term Sheet Hacks is a work in progress and we’re looking forward to learning more from your comments and emails.

These articles assume that you either have a term sheet in-hand or are anticipating one. If you need a basic understanding of term sheets, read Brad Feld’s term sheet series and hire a lawyer.

Before you go on, please read our disclaimer:

This site provides information. Use it at your own risk.

Information is not the same as legal advice – the application of information to an individual’s specific circumstances. This site does not provide legal services or legal advice.

Although we try to make our information accurate and useful, you should consult a lawyer to interpret and apply this information to your particular situation.

We are not lawyers and we do not take any responsibility for rashes, financial ruin, or anything else that follows from applying this information.

Our first two hacks show you how to create a board that reflects the ownership of the company and why you should make a new board seat for a new CEO. We also maintain a list of all the term sheet hacks. Please do read on…