November 10, 2010
You know that once you have found the right investor for your company, you will have to negotiate with those investors in order to seal the deal. You also know that this is not very easy to do. Investors who invest a large amount capital will want to have their amount of equity in the company for that investment.
You need to make sure that you get your share of the company as the founder of that company. So, how do investors exert control over your company? There can be several different answers to that question. In the least case, the investor will want a seat on your board of directors. In case of a syndicated investment, all the investors involved in the investment will want to have a seat on your board of directors. Now, the question arises how you and your investors collect each other’s profits.
In theory, you should expect to have a controlling share or own controlling stock in your company. This means that as the founder or co-founder of the company, you would want to have at least 51% share in your company. Investors will also have their demands and their required amount of shares in your company also. Furthermore, when an investor sits on your board of directors, he in effect has a controlling position in your company and has a say in how your company operates. That’s not all, however.
The key thing to look at when dealing with investors is that your company shares get diluted. This means that a company has 100 shares, you own 50% and your co-founder owns 50% of the company. Now, when the investor comes in to play, he wants 50% of the company also, and if you agree to that, you will have to allocate another 100 shares of the company to the investor. This means that the company shares become diluted, and you still own 50 shares, but the percentage has been diluted and instead of 50 shares being 50% of the company, it now becomes 25% of the company.
Valuation is also very important when negotiating terms with your investors. Basically, in a nutshell, valuation is the price the company is worth after an investor has invested his money into it. When discussing valuation, you need to know the difference between pre-money and post-money valuation.
Basically pre-money valuation is what the company is worth before it has any of the investor’s money invested in it. What is the company worth? How much equity does it already have? These are all questions that need to be answered before seeking investors to invest in your company.
On the other hand, post-money valuation is how much your company is worth after the investor has invested his money into it. This is very important. Investors may require a certain amount of valuation before agreeing to investing any money. Suppose you are asking for $1 million. The investor wants to know what your company is worth at present before investing that $1 million in your company. This can be a difficult negotiation term for new startup companies, who’s pre-money valuation may not be even half of that.
The best way to better your chances is to create a competitive market among investors for your company. If you have more than one investor giving you a terms sheet (which is a document that contains the terms and conditions of the investment granted to the entrepreneur from the investor), you would be much better off in setting your terms and conditions for signing the terms sheet when you have a competitive market with several investors bidding to invest in your company. With VCgate, you can broaden your horizons and have more investors bidding on your company. This can lead to having more than one term sheet and you can choose the best one to work with.
There are many other things to look at when setting up negotiations with investors. You also need to remember, that each investment firm who invests in your company will require at least one seat on your board of directors as a condition for the investment. In most cases, the more seats investors have on your board, the more shares they hold in your company. This means that you will have to find a middle ground and decide together with your investors who gets what shares of the company. Investors will want to have their set profits from the money they invest in your company. You need to remember that money investors invest in your company basically means that these investors are buying some of your company’s equity.
It is always good to look at the conditions carefully with your legal counsel before signing the terms sheet to avoid loosing out on the capital you could be gaining from your venture. Furthermore, there is also a way that you can have control of your company, even though your investors have more company stocks. All you need to do is to have more of your people on your company’s board of directors. The board of directors is the controlling arm of the company and if more people from your management sit on the board of directors than investors do, you control the company.
All the best and good luck.
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