3 Rules to Startup Negotiations

Feb 05, 2011

How to negotiate your pre-money valuation and terms with a venture capitalist or angel investor.

The pre-money valuation and terms of your startup can be a touchy subject for many Entrepreneurs, VCs, and angel investors.  It always seems the Venture Capitalist wants a lower valuation at a higher term, the Entrepreneur wants a higher valuation with a lower term.

Why such the touchy subject with a pre-money valuation and terms?  With your first insitutional round, there really is no set amount, and there is no such thing as a 100% accurate pre-money valuation with a startup.  It’s all about  how much perceived risk your venture capitalist or angel investor anticipates.  Or rather, how much of that perceived risk you’ve eliminated.

Here are 3 simple, straightforward rules for negotiating with a venture capitalist:

1.  Get an Attorney for Negotiations!

We often think we can negotiate our startup’s pre-money valuation without an attorney.  An attorney will only cost you a few thousand dollars, but has the potential to save you millions should your startup become a success.

Any decision you make with your startup’s pre-money valuation, and the terms associated with your first institutional round, will affect every future round, money, control, taxes, and many other factors.

2.  Know the VC or Angel Investor

Always strive to learn more about the venture capitalist or angel investor prior to any pre-money valuation or term negotiations.  A few good questions to ask:

  • What level of ROI does this investor want to achieve?
  • How long does this investor expect to hold this investment?
  • What growth percentage do they reasonably expect?
  • Is this investor active, mentor type, or inactive (cut the check and run)?

3.  Know what you want, and what your startup needs.

Before you begin any negotiation, whether it’s pre-money valuation or term negotiations, have a good idea of what you want; and what your startup needs.  Do you need someone to take control?  Someone has to.  Do you need guidance (mentor style investor)?  Mentorship is valuable to many first time Entrepreneurs (and is a much better approach then control).

Tips for starting off the pre-money valuation and terms negotiations…

Start by looking for areas of agreement your startup’s pre-money valuation and terms.  Don’t start off in an adverse position.  I always start with picking out the items of agreement.  I state why I agree with them.  It’s like saying “hey, this glass is half full (not half empty)…now let’s negotiate on how we can make it full”.

As a startup founder, or startup CEO, it’s important to be a fair and realistic negotiator.  Negotiations are never about trying to get the most, or the least…it’s about fairness.  Remain flexible, keep an open mind as to where your investor is coming from.

If he’s an angel investor, there’s probably alot of fear surrounding this investment.  It’s a big risk, but a potentially huge return.  This may be his retirement fund he’s pulled out of the stock market, because it’s just going down.  This could be his life savings.  Be respectful to your investor as a startup, they have just as much pain as you.

If your investor is a venture capitalist, he’s got a different set of worries.  He’s really worried about risk, returns, and numbers.  Venture Capitalists use OPM (other people’s money).  That means they have a flock of investors they have to please.  That’s a lot of pressure weighing on his shoulders during pre-money valuation and terms negotiations.

And investors, well..consider most Entrepreneurs have had to literally obsess over their startup just to make it to where they are.  When you put your life, your passion, all your time into something…it’s very hard not to take a personal approach to negotiations.  Work to understand your entrepreneur’s situation and attachment to their business.  There is no such thing as founder’s syndrome.  A founder can be the most obsessed person with their startup, but every founder has the same end goal: freedom.

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