There is a lot of discourse in the financial media these days about how to go about raising capital for your business, investor expectations, getting pitch-ready, etc. But there is little if any chatter on what to expect in the event that you actually become one of the golden eggs who manages to secure funding from investors.
T.S Eliot once wrote that “the end is where we start from”, and this is definitely the case for start-ups post the end of a successful capital raising program.The capital raising process is exhaustive to say the least. About 300-500 conversations are required in order to get the right introductions to the right people. Another 100-200 conversations are required with investors in order to secure funding.
It is no surprise then that a new lick of funding can have you popping the cork on the champagne bottle. But this moment in time really is just the beginning.
The headaches for an entrepreneur typically ferment when they jump at the first offer of equity from an investor, without giving proper consideration to the terms that are negotiated with that investor.
Show me the money!
Rushing through the negotiation process—in an effort get much needed funding down the wire and into your bank account—can mean giving up important economic and control rights without you even knowing.
If this is the case then you might be in the gun for a few headaches down the track, or worse, watch your start-up ambitions fade like a ghost in the night.
But it’s not all bad if you take into consideration some key terms before you sign a marriage certificate with your new investor. Your business is your baby after all so losing control is akin to giving your child up for adoption in some cases.
Don’t be a victim. By taking a breath and pausing for a moment, it is possible to build a happy marriage with your new investor(s).
When you do finally get a seat at the negotiating table with an investor, then you're at a distinct disadvantage right from the get-go. Why? They have likely done this a lot more times than you have.
But in general, an investor’s needs aren't that scary and can usually be broken down into two broad categories: economic needs and control needs.
An investor needs some type of certainty in order to be fairly rewarded for their investment in an early-stage business like yours. This means whey will need some type of secured interest if your business fails. This fulfills their economic need.
Second, they will want a say in major decisions about how your company spends money. This fulfills their need for control.
Deal terms have become ever more complex in the past decade, but the bulk of terms spawn from the two basic needs mentioned above. And this is where a commercial lawyer really starts to earn their keep—a good one is worth their weight in gold.
Economic needs that you need to discuss with your lawyer include:
No other point of your agreement will be more fiercely negotiated, and no other point will have such a profound and pervasive impact on the future of your business, and you personally.
Your initial valuation establishes a one hundred ton anchor in the ocean that will exert influence on what the market thinks your company is worth long after your first round of funding.
A fine balancing act
You have to remember that investors have their own self-interests in mind, not yours, when negotiating terms with you. Your goal as an entrepreneur is to give the investor everything they need—not what they want—in order to alleviate this.
The investor also has an incentive to focus on risk, and in general, you as the entrepreneur have the incentive to focus on opportunity.
Further, an investor will be inclined to believe that they are worthy of special treatment. But in general, you as the entrepreneur have the right to argue that you are the leader of a business, building a team, and teamwork requires fair play. This is one negotiating position that the investor doesn’t have.
How you use this negotiating position to reach an agreement on investment terms can determine the success or failure of your business, and even your own economic future.
Getting it right, or being aware of it at the very least, can hopefully create a few less headaches down the track. As if building a business isn’t hard enough. Don’t let your start-up ambitions die with the ink of a pen.
This article is general in nature and some of its content cannot be regarded as legal advice. It is general commentary only. You should not rely on the contents of this article without consulting professional advice from a commercial lawyer or corporate advisor.