In this follow up article from "Venture Capital Case Study" we address the seventh step in securing venture capital. Article 9 to follow.

The investor has been impressed with your proposal, and is comfortable with your management's capabilities, and is now showing serious interest in investing in your business by requesting further meetings and information.

Although both parties are trying to arrive at a win-win situation, the negotiations will probably still start at quite different positions with a gap in the middle that both participants will move towards. It is your job, (or one of an experienced negotiator if you require their services), to close that gap and make a deal. Your needs will be stated in your financial statements and in your proposal. The investor will provide you with their specific needs either written or verbally.

Negotiations aren't a simple process. They are complex. There are a few simple skills that you should learn that can assist you in creating a deal, saving you money, and get your business moving. The following process is a detailed but not exhaustive list of areas that you will have to consider:

1. Develop a Negotiation Plan
 
You should develop a negotiation plan that maps out your position on various financing issues, such as profit sharing and ownership participation. You can then discuss, and obtain a consensus on, these positions with your management team and advisors (if applicable), and understand the impact of your position before meeting with the investor. You should consider several options, which can be presented to the investor in order to achieve common ground. Remember the investor is primarily looking at their rate of return, your management team and structure, a sound business opportunity, and an exit strategy.

As part of your negotiation plan, you should define what is important to you.

• Establish your goals and the underlying principles and objectives. This process will allow you to keep the discussion focussed on objective criteria instead of emotions and personalities.
• Your goals should be flexible. Identify goals that are essential and items that you are willing to give up to achieve a deal. Your main objective is to achieve a deal, not to win each and every point.
• Establish the essential elements, including your opening position, your bottom line and acceptable compromises.
• Consider issues other than just money. You should review issues such as control of the business over time, the value added by the investor, expanding the board of directors to include other outside directors, etc.
• Once you have defined your goals, compare them with the investor's needs. Think of alternatives for goals on which you may appear to differ.
   

2. Valuation Issues
 
You will have determined the value of your business whilst carrying out the work on the investment proposal. This is based on the predicted future market demand, and the share of your company you are prepared to relinquish. You may not wish to disclose this information to an investor, as it could set a ceiling on the value of your company. If you do disclose the price, then back it up with the relevant information. The market will dictate to a large extent what your business is worth. The price will vary due to the investor's knowledge of the market and the extent they are willing to get involved. There are also many ways to structure the value of the business, by way of clauses regarding future performance of the company. It's an insurance against future failure for the investor.
 

3. The Key Elements of the Negotiation Process are:
 

• Control;
• Performance objectives;
• Exit options;
• Anti-dilution provisions;
• Employee contracts;
• The board of directors; and
• The term sheet.

A term sheet is a short two or three-page document that outlines the investment agreement between an entrepreneur and investors. It is a very important document that signals the serious intentions of the investor. You may go through various drafts till you come up with an agreement. Typically it contains the following elements:
 

• Total investment;
• Equity investment;
• Loan component;
• Class of shares;
• Percentage of total equity of company to be acquired;
• Dividends and dividend priority;
• Components of shareholders agreement;
• Debenture or security agreement, subscription amount, interest rate and how calculable and payable, term of loan, principal repayment, representations and warranties, reporting and events of default;
• Payment of expenses and fees;
• Condition precedent to completion;
• No material adverse change in the affairs of your company;
• Completion of audited financing statements; and
• Lapse date of closing.
   

4. Negotiation Mistakes in Risk Capital Negotiation include:
 

• Poor or inadequate preparation;
• Asking for unrealistic terms at the outset, which affects your credibility;
• Playing with the truth and underestimating the other party's abilities to perform the due diligence review;
• Unrealistic expectations about your product's sales potential (investors refer to this situation as "hockey stick" growth expectations where a graph of sales growth versus time looks like a hockey stick);
• Being too accommodating to the other party just to close the deal (be prepared to walk away from an unfavourable deal);
• Ignoring or not trying to understand the other party's position and needs;

• Failing to listen carefully to the other party, resulting in you assuming an issue is resolved when it is not (this will cause friction later in the negotiation when the issue resurfaces, and may result in your inability to close the transaction);
• Establishing a position that will be impossible for you to back away from without losing face (for example, by refusing to give up more than 20% of your company, your flexibility is severely compromised, and sticking to such a rigid position may not give either party enough room to arrive at a mutual agreement);
• Beginning negotiations too soon or before the other party's interest and understanding of your opportunity is fully developed; and
• Assuming you have no leverage (remember, the other party would not be there unless he or she could gain by doing business with you).

Remember that investor's may challenge every statement you make. Make sure your statements have hard facts to back them up,
 

5. Best Practices in Risk Capital Negotiations
 

• Put in the time to prepare. Investigate the other party as much as possible and know your own position thoroughly.
• Prepare detailed alternatives and try to determine what the other party's alternatives might be.
• Know your material well. Understand your bottom line on all major issues.
• Use an advisor. This will give objectivity to the negotiation and remove some of the emotional reactions and the potential for a battle of wills between the two parties. An advisor can facilitate the negotiations by keeping the focus on objectives and criteria (win-win) and avoid deadlock positions (win - lose). You can also benefit from the advisor's negotiating experience.
• Understand your own concessions and why you made them. Are your criteria appropriate?
• Control your emotions, perceptions and the way you express your ideas, needs and observations. Negotiation is fundamentally a game of human relations.
   

Relax and remain objective. Remember, the worst outcome is when no deal is achieved and you need to start your search for another investor. This is better than accepting a poor deal, which will impair your chances of success or cost you control of your company. What are marketing strategies?