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Negotiate with investors from a position of strength
Investors are powerful partners, but you need to know how to protect your payout.
Negotiate with investors from a position of strength
It’s the victory no founder wants. You’ve built and sold a successful business that has taken years of emotional and financial investment, but you walk away with little or nothing to show for it.
Often, this happens because you have agreed to terms that have tipped the scales in favour of your outside investors, leaving you and your employees with little return from the sale of your venture.
Outside investment can be the pathway to growing a business. It makes the pie, and the sum of its parts, bigger than it ever could have been through organic growth.
Equally, it’s reasonable for outside investors to place conditions on their investments, especially on an untried and tested venture. Ultimately, they are making an early bet with their investors' funds on you, your idea, and your ability to execute. All of which remain broadly unknown and, crucially, unproven entities.
This scrutiny is intensified by the current interest rate environment. Funding and risk appetite are tight, and investors are placing higher demands on their investments to ensure they get the kind of returns they’re looking for.
Shaping an agreement that suits both founder and fund can be a challenge, especially if you fail to consider all the equity terms and agree to a deal that has not been fully considered from all angles.
So how best do you enter these negotiations? It starts with understanding the rules of engagement.
Term sheet terminology
If you’re going to seek outside investment, there are a myriad of terms and language that will be coming your way. The key is to negotiate a term sheet that works for both sides.
A term sheet defines the basic terms and conditions of a proposed investment. Unfortunately, they can be complex, and full of legal terms.
Here are some key ones to understand and anticipate.
Preference shares
These are like being in a queue where you get special treatment. When a company reaches a liquidity moment like a sale or wind down and begins the process of paying back the money it owes, people with preference shares get paid first, before others. This is a smart safety feature that investors like using to protect their money against the value of their investment falling.
Participating preferred stock
Investors often want a special deal for the early risk they are taking on where not only do they get their initial money back, but they also get to be first in the queue to take any extra profits. The proportional value can be double or triple their investment. This can often be 2 or 3 times the multiple of their initial investment.
Anti-dilution provisions
These protect an investor’s ownership percentage against later rounds when the company issues shares in the future at lower prices.
6 ways to protect your payout
It’s clear how tough these terms can be on squeezing founders, and it gets compounded over the lifecycle of your venture as it sets the standard for later funding rounds.
What are you going to do? Acknowledge that it is on you – the founder – to strategically plan, negotiate, and execute any future outside funding. There is no one forcing you into these terms.
Start early | Don’t negotiate in desperation. It’s better to build your business organically and demonstrate milestones and a sustainable pathway to then negotiate from a position of strength. |
Get it right from the start | The key is to strike the right balance and terms that fairly reflect the risk that investors are taking versus the potential and viability of the business. |
Build for the future | Be clear on what is non-negotiable, and where you will draw the line on negotiations. |
Ensure alignment | You and your investors are entering a partnership: like any, a little give-and-take is needed on both sides. While an investor is coming on board because they believe in your business, they need to have a longer-term view and understand there may be ups and downs before the goal is hit. |
Choose the right partners | Who believe in your vision and your ability to deliver. You also need to understand the pressures your partners are under from their investors. |
Ironclad terms | Remove any ambiguity around the key equity term points. |
The terms you agree to can affect how you run your company and the control you give up over the investment. It’s a delicate balancing act to make sure you’re acting in the best long-term interests of everyone.
Sometimes that means a strategic compromise for the funds you need. Other times it might mean declining the investment if the terms don’t suit.
The exit from a successful and growing business should be a moment of considerable pride and provide a sense of “mission complete.” It’s up to you and your investment decisions that will determine if this happens.
