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October 12, 2010

How to Negotiate With Venture Capitalists

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Venture capitalists are motivated by huge profits in short order. They seek to double, triple, or quadruple their investment within five to seven years. As such, they will do everything they can to lock in the greatest possible return on investment (ROI) from your company when issuing you a term sheet or stock purchase agreement.

That is not to say VCs are vipers bent on sucking the life out of your company. They are your allies in your quest to grow your company quickly and make a killing. They are fully aware that you too are motivated in part by profit. They are never likely to rob you of your incentive to succeed.

However, once you sign a term sheet – that is, a non-binding agreement stating the general terms of ownership over the company upon funding – the negotiating power shifts from you the entrepreneur, to the VC. There is where valuation, liquidation preferences, board control, and other factors are set forth.

Receiving a term sheet is an occasion to celebrate – cautiously. It usually means the VC is serious about investing in your company. The term sheet is the critical first step in the stock negotiation process. You must get a lawyer at this point to level the playing field. Your ignorance is a liability, and investors know this. It will not be their fault if you fail to hire lawyer.

You and your lawyer will review the terms laid out in the term sheet. You will then communicate with the VCs to determine a final stock purchase agreement – the official sealing of the deal – that is most beneficial to you the entrepreneur.

The single most effective way to make that entire process easier is by securing multiple term sheets from multiple firms simultaneously. Create a competitive market of venture capitalist firms by contacting them all within the same week or two. In your teaser emails, state that you will be looking to close the round of funding for X amount of dollars, at such-and-such a date. This creates a sense of urgency among your target VCs.

The simple law of supply and demand really works. There is only one of you. With many of them, your value goes up. This tactic also helps level the playing field when a VC firm locks you into a “no-shop” term sheet, which prevents you from shopping your company to other investors while the VC decides whether to fund you.

Finally, securing multiple term sheets simplifies the negotiation process by nipping many problems in the bud. The more leverage you have over VCs by creating a competitive market in your favor, the more favorable the final terms are likely to be when you are issued a Stock Purchase Agreement.

Want venture capital? Click here to watch this free presentation.

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