As a new or growing business looking for angel finance or venture capital you need to be prepared for finding a funder prior to that actually happening. To often do entrepreneurs look for business funding without actually thinking that they may get it. So what is that you need to be prepared for and once you have chosen the individual investor or VC firms that you want to wrk with, what will be covered during the negotiations? The key to successful negotiations for venture capital is in the details of the issues coverd. These issues which need to be well defined and agreed upon will normally be as follows:
Business Valuation. The value of the business is normally the the first negotiating issues. Valuation or the price of the company in which the venture capitalist invests, most often will be very different depending on who you are asking. Valuation determines what percent of the company the investor is buying for their capital. Obviously as the entrepreneur who have put many hours, heaps of effort and often much of his/her life savings into the initial development of the business, will value the business at a much higher level than that of the venture capital firm who;s aim it will be to get as large a share of the business as possible for the money they are willing to invest.
Timing of the Investment. Many investors will commit a large amount of capital, but will contribute that capital to the companies in installments. Often, these installments are only made when pre-designated milestones are met.
Who will be in the Management Team. Some investors insist that additional or substitute management employees be hired subsequent to their investment. This gives investors additional security that the company will execute on its business model. An important issue to negotiate with regards to modifying the management team is the amount of stock or options that will be issued to new management team members, as this will dilute the holdings of the founders.
Roles of key founders and the agreements attached to that. Venture capitalists & Business Angels typically do not want companies to have employment agreements that limit the circumstances under which employees can be fired and/or set compensation and benefits levels that are too high. Other key employment agreement issues to be negotiated with VCs & Business Angels include restrictions on post-employment activities and employee severance payments on termination.
Copyrights, patents and intellectual property ownership. If the company has an important product with intellectual property (IP), investors will want to ensure that the company, and not a company employee, owns the IP. In addition, investors will want to ensure that new inventions be assigned to the company. To this end, investors may negotiate that all employees must sign Confidentiality and Inventions Assignment Agreements.
Exit Strategy. Most often, Investors will be very focused on how they will get out of the business once their expected returns have been accomplished. Here they will negotiate regarding registration rights (both demand and piggyback); rights to participate in any sale of stock by the founders (co-sale rights); and possibly a right to force the company to redeem their stock under certain conditions.
Right to the shares in the business. Venture capitalists & Business Angels may require a lock-up period at the term sheet stage. The “lock-up period” is typically a 30-60 day period where the investors have the exclusive right, but not the obligation, to make the investment. Investors typically conduct due diligence during this time without fear that other investors will pre-empt their opportunity to invest in the company.
Each of these issues is critical when raising both angel finance and venture capital, since the outcome can significantly impact the success of the business and the wealth potential of the company founders and management team. Because Venture capitalists & Business Angels are very knowledgeable regarding these issues, and have great skill in negotiating on them, companies who are raising angel finance or venture capital should seek advisors who also have this experience and expertise.
Although some serial entrepreneurs may have been there and done that when it comes to venture finance, many of you reading this blog may be inexperienced in the process. Remember that the Business angel or VC firm who you will be dealing with may have been down the same road with various other businesses you need to be fully prepared by the time you start having conversations with them.
Happy finance hunting!
