By: Ryan Floyd co-founding MD of Storm Ventures
As a venture investor in early stage B2B startups, I try to be actively involved in my portfolio companies to help them succeed. That means guiding them on things like hiring, strategy, and financing. But as much as it might bruise my ego, sometimes it can mean simply stepping out of the way and letting the entrepreneurs get on with it. It seems like such a low bar – but listen to some of the horror stories entrepreneurs tell about their relationships with investors and you will quickly see it is a more common situation than it should be. Here, I outline the key things a founder should be aware of when negotiating with and choosing the right investor.
Research the right investors
It’s crucial to carry out diligence on potential investors. Ask direct questions and aim to get to know the investor well, not just by running through financials and your slide deck but perhaps over a meal (pandemic aside). Get more of an idea of what it will be like working with them by asking them about your business and what they would do. Most investors talk a good game, but not all can deliver.
Find out about their life and career; how they ended up in the venture world, challenges they overcame, and what they have found to be the attributes essential for success. Trust and integrity are critical in the early investor relationship, as they will likely become a big part of your company’s journey going forward.
Negotiate the Term Sheet
A question I’m asked often is whether it’s appropriate to negotiate a term sheet against the risk of offending the venture fund and losing the opportunity altogether. My answer is that you should feel 100% confident when it comes to negotiating with investors. If an investor walks simply because you are advocating for your company and yourself – they are not going to be a good partner.
Don’t be shy about asking for things that are important to you. Venture investors make lots of deals and are well accustomed to having these conversations. Importantly, now is a chance to get a view of how the individual on the other side of the table is likely to behave in the future, especially on sensitive issues. At the same time, be aware that an investor is getting a sense of you as well. Are you reasonable, do you focus on yourself only or the whole company, etc.
Sometimes it’s not obvious what is most important to the venture firm. Founders assume that pre and post-money valuation come first, but often it turns out that investors are more interested in ownership. For them, the chance to invest a specific amount or obtain a certain amount of the company is more important than the valuation itself. So, you need to ask the right questions if you want to achieve mutually favourable terms and find common ground.
In my experience, quality venture firms don’t put out term sheets that lowball opportunities. They are more thoughtful than that, as reputation is important to them, and they know a reputation for lowballing will deter other potential entrepreneurs. Terms offered will generally fall into the ‘zone’ of what that venture investor genuinely feels is reasonable.
Some terms come with flexibility — the necessity of board seats, how many seats, and the issue of observer rights, to name just a few. You will find the least flexibility generally on the economic terms.
In some cases, it might be necessary to ask for an extension to the deadline. Perhaps you’ve been working hard and they gave you 24 hours to sign the term sheet. Maybe you’re awaiting a response from other firms, or your lawyer hasn’t had the time to fully scour the text, or you’ve been trying to close your biggest customer so far. Meeting these deadlines shouldn’t be rushed. Get most of your work completed before you receive the term sheet so you can focus properly on it.
Seek legal advice on the Term Sheet
Spend time with your lawyer understanding the basic terms. Storm Ventures’ term sheet is very short, only a page-and-a-half, and that’s fairly representative of most venture firms. Understanding the terms is important because it helps to speed up the process significantly. If you go back to request an extension, you need to articulate the reason.
Any proposed extension should last only for a short period — unless you’re willing to let that fund go. Once a venture firm offers you a term sheet, they won’t want to play the role of a stalking horse so you can negotiate a better deal somewhere else. They can’t be expected to wait for a week, say, while you’re talking to other firms, unless you feel like you have an incredibly strong story and business.
Having multiple firms converging all at the same time with offers is a good strategy, so you don’t have to ask anyone for extensions.
Build a relationship with your investor
Signing a term sheet is not just a cold transaction. Once an investor puts money into your company, they are going to be with you for a very long time. Enter an arrangement with the view that it’s the beginning of a relationship. Investors are not buying a car, and you’re not selling one. You are business partners.
Be as transparent as you can about what’s important to you, and your thoughts on valuations, fundraising, and more. Use the opportunity in the negotiating stage to build familiarity and address difficult topics. However, if you play games, experienced investors will pick up on that.
Don’t risk anything by bluffing your hand. If there are other interested parties you’re spending time with, let the fund know, but keep it brief and matter-of-fact. A rough idea of timelines and scale is all they need.
Most importantly, be aware that every startup has a cadence and personality of its own. Any experienced investor knows that and should let you take the lead on how to mould its success. If they talk too much and don’t listen enough, and if they appear to want to take your company in a direction you know won’t work, listen to your instinct as they probably are not the right investor for you.