What negotiating tips would you give for my discussions with an investor looking for equity? How can I make sure that I don’t give away too much equity or end up with a generally bad deal?
The guiding principals are that your relationship with your investors needs to be open, realistic, able to cope with periods of stress as well as success, and with a time horizon from investment to exit of three to five years.
The common challenges that early stage investments face revolve around three key issues – expectations, valuation and deal terms.
Within the first two meetings you need to have a good “gut feeling” that you can work with your investor, that you trust each other, and that you can communicate effectively. Your investor also needs to be clear with you on their timing and motivation.
- Do they want to be in and out of the business in two or three or five years?
- Do they want to be a passive investor or actively involved in board, or executive, decisions?
The first round of investment should leave a founder with a majority stake in the business. If you need $50,000 to prove your business case you will aim to sell 10-20% equity to your investor. So work your valuation backwards from there.
If the investor wants to control the business at this stage, or wants “step in” rights, or direct involvement in operations, then you may not have aligned expectations. It may be better to part ways amicably now, rather than incur legal fees on a deal that might not be “right”.
If you cannot agree on valuation at the start of the “courtship” phase, you will have greater problems through the business “marriage” and any “divorce”!
3) Deal terms
One way to reduce valuation conflicts is to structure deal terms that reward operational milestones. This might take the form of half the investment funds committed at a lower valuation, with an agreement at a higher valuation for the second tranche of funds to be paid once certain milestones are achieved.
To avoid a “bad” deal, you need to:
- agree on goals and expectations;
- retain control of your business;
- not agree to terms that allow the investor to step in, or to take over the business.