Q. Dear Zenagos,
I just got a term sheet from a potential investor. They are real sharks, and I’m afraid I’m going to give away too much. How do you negotiate with big-time people?
You negotiate with big-time people the same way that you negotiate with all other people – carefully. It is important to prepare prior to any important deal meeting. Here are some things to consider:
Bring an Attorney
You may think you can’t afford an attorney. (They do charge a lot!) However, you really can’t afford not to have an attorney. You need someone on your side of the table who knows the risks involved in taking money from investors and will protect your interests. Even if the investors don’t have their attorney at the table, you can bet that they have every transaction reviewed carefully by their legal counsel.
Decide Whether to Accept the Terms as Offered
When you receive a term sheet from a potential investor, one of your options is to sign it and accept the terms. You need to be aware that if you start negotiating, you are telling the investor that you do not accept the terms as offered. Once you start negotiating, the investor can choose to ignore the term sheet and abandon the deal. It is important to know that if you don’t accept the terms as offered, you are risking losing the deal entirely. So, don’t bluff – if you want the deal, and the term sheet is close to what you want, take it – don’t negotiate just for the sport of it. If you are willing to walk away from the deal unless the terms change, then you are ready to negotiate.
Know Your Bottom Line
Before you enter the negotiation, it is important to review your financials and understand the investor’s perspective on the opportunity. Investors typically expect a healthy return in exchange for the risks they take (such as 20-30% per year, compounded), so you need to take that into account when you decide what terms you are willing to accept.
If you don’t know how to make a financial forecast, then you need to hire a business advisor who does. Many entrepreneurs have an unrealistically high number in mind because they do not understand how investors value a business. In many cases, you need to accept less for your first business, so you can build up your financial reserves and own more of your subsequent businesses.
Once you know the absolute limit of what you will accept, then work out your opening position. In the initial jockeying of a negotiation, it is common for each party to try to get the other to set the opening terms for the negotiation. In case you decide to make that opening, it is important to know where you will start the negotiation. For example, if your bottom line is that you will accept no less than $50,000 for 20% of the company, then your opening position might be $50,000 for 10% of the company. Make sure you have clear arguments for why you have taken each position.
Believe Your Bottom Line
As the other party in the negotiation tries to figure out how low you will go, they will look for all kinds of involuntary signs or “tells” about what you really believe. Once you have set your bottom line, you must believe with all of your heart and soul that it is in fact the lowest that you will go. If you waver, then that gives the other party leverage in the negotiation. If they believe that they can push you lower, they will not stop trying.
No matter how the negotiation goes, you should be proud of your progress. If a “big-time” investor has given you a term sheet, then you have just received a strong endorsement of your idea. Even if this deal doesn’t work out, you will learn a lot from the negotiation, and you will be better prepared for the next opportunity.
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