Tips for negotiating an investment with venture capital

When will it be sold? Will all shareholders sell at the same price? Could it have new investors? Tips for negotiating with venture capital

Financing is the litmus test that a startup faces, understood as a fast-growing (scalable), immature business project with high doses of uncertainty about a market that is yet to be created.

It will be vital to continue developing your product, increase the team or look for new markets. The day after signing a financing round with professional investors, almost everything will have changed for the entrepreneur and his project: a good part of his future will be marked by what has been signed. When will it be sold? Will all shareholders sell at the same price? Could it have new investors?

In the book 'How to close financing rounds successfully', Manuel Matés, entrepreneur, investor and co-founder of the Big Sur Necotium fund, adapts into Spanish one of the reference works on venture capital investment in early business stages, written by Jason Mendelson and Brad Feld, authors of the AsktheVC blog and founding partners from the technology venture capital fund Foundry Group.

It is a practical guide for both novice investors and entrepreneurs that provides an exhaustive review of the technical, legal and human aspects surrounding an operation of this type. “Anyone who has participated in a financing round with venture capital knows the difficulty, effort, energy and patience that it entails,” explains Matés, founder of projects such as Olé, Cinet (in the 90s), professor at Esade and venture capital investor. It serves to understand that the entry of professional venture capital investors will mean, in most cases, the future sale of the company, either to another investor or to another competitor.

Although it seems that a large professional investment in a startup is a game of two between a venture capital fund and the entrepreneur, in reality, a large number of actors are involved that can help or hinder a successful operation. From the mentors and advisors of the project, the 'business angels' (initial investors) or the lawyers themselves in charge of negotiating what percentage of the company will be sold, in exchange for how much money and, above all, what guarantees and fine print will be included in the contract and the partners' agreement.

From this dark side of the financing and investment contract, possible and unpleasant surprises will arise in the future, such as the investor making money with a potential sale of the company and the entrepreneur who created it not (preferential liquidation clause); that the project has to close due to disagreement with new capital increases despite the fact that there are other investors willing to put it on the table (ability to veto increases or sales).

There are also other clauses, mostly veto clauses, aimed at protecting the investor, which can prevent the payment of a dividend to shareholders; the request for a simple loan from the bank; or even change the status of the company, its activity or the composition of its board of directors. In this operation, the limits of dilution or discounts (warrants) of the participation of entrepreneurs and investors will also be set when it is necessary to increase capital and bring in new money.

On the other hand, entrepreneurs must take into account the difference between investment and convertible debt. The first is a direct purchase of shares and injection of funds into a company. The second is a loan that is converted into shares over time, or when another subsequent round of investment occurs. This formula is, in fact, one of the most common by professional investors when it comes to financing startups and can entail future risks for the entrepreneur if they have to close the company.

“No matter how much you think you know, or have read, hire a great lawyer. In many cases you will be the most inexperienced person at the negotiation table.”, Feld and Mendelson point out in their guide. It will be the image of the entrepreneur before his future investors. Not only the final result will depend on it, but also the state of the relationship with the new shareholders once the partners' agreement and the financing round are signed, as well as the options that the entrepreneur will have in the event that the project succeed, fail or be forced to sell.

This is an investment proposal or letter of intent from another investor that details some of the financing or investment conditions in a company. This is a rookie mistake and will denote inexperience because it will mark a starting point or reference point in the negotiation that could have even been improved if not shown.

Don't ask for a confidentiality agreement (NDA, for its acronym in English). Venture capital funds receive hundreds of investment proposals, in many cases, with similar or similar ideas. They will avoid this type of prior agreements because they would not be able to talk to other investors about the project to co-invest or they would get into legal problems if they invested in another similar startup. While investors almost never sign NDAs in the context of an investment, these will be mandatory in an acquisition.

Don't spam your company's potential financial partners, or insist too much when an answer has already been given. “Investors tend not to react well to spam.” No, often, means no. “Something you should know is that if we say no, it doesn't mean your idea is stupid, it just doesn't mean it's not for us,” the guide notes. In the case of refusal, experts recommend not requesting a presentation or reference from another investor in the same sector because it would imply a recommendation and, at the same time, a first refusal of investment.

With some exceptions, the chances of obtaining financing if you do not have a team around the project are slim. First, because no one can do everything. Second, it is an alarm signal for the investor. And third, often the team executing an idea is more important than the idea itself. Feld and Mendelson also recommend not overdoing patents as an element of project valuation due to the legal risk that their defense may entail and they are not applicable to all technological sectors.