How do you strike a great deal that works for everybody? When it comes to startup funding, this is the key question faced by early-stage investors and founders.
Getting the deal right will lay a strong foundation for a strong and productive relationship. By contrast, a lop-sided or poorly-conceived deal can create big problems later, possibly leading to resentment and stalled growth – favouring no one.
Negotiating terms is a nuanced process that blends finance, legal savvy, interpersonal skills and strategic foresight. In this guide, we offer some insights from our exclusive investor network at Bure Valley Group, helping you protect your investment and lay the foundation for a constructive partnership with startup founders.
Understanding Your Role and Objectives
Before entering any negotiation, clarifying your role and what you aim to achieve is vital. Angel investors typically provide capital at an early, often risky, stage of a business.
In return, you may seek:
- Equity ownership
- Board representation
- Information rights
- Liquidation preferences
- Anti-dilution protections
Think carefully beforehand about what your focus is. Are you looking purely for financial return, or do you place a high value on strategic involvement? Are you seeking to provide mentorship or even social impact?
A clear picture of your purpose and priorities will help you align your negotiation stance.
Due Diligence
The more you know about a startup and its marketplace beforehand, the better-placed you will be to secure your interests in negotiations.
This is not about trying to “catch out” founders during the pitching process. Rather, it’s primarily about maximising your ability to assess risk accurately, gauge valuation and identify red flags.
Here are some areas where you should consider running thorough due diligence when considering a startup:
- Business model and market potential
- Financial health (burn rate, revenue, runway)
- Founding team’s background and commitment
- Capitalisation table (who owns what)
- Intellectual property (IP) and unique differentiators
- Legal structure and compliance
Know the Market Norms
As a rough guide, an angel investor might seek a 10% to 25% share of an early-stage business in exchange for funding. However, market standards are not universal across every sector.
By taking time to understand the unique norms, etiquette and benchmarks of a startup and its sector ahead of time, it can avoid awkward and counterproductive negotiations later.
If you are unsure where to look, consider exploring reference materials such as the NVCA Model Legal Documents or Angel Capital Association for more information. For a UK-specific resource, see the British Private Equity & Venture Capital Association (BVCA).
Be Firm on Your Limits
We all know that our emotions can get the better of us – even experienced investors. This can happen when a startup pitches an idea to an angel investor.
Without self-imposed boundaries on what you are prepared to give and take, you risk making decisions solely on “gut feeling”, possibly leading to over-commitment or suboptimal terms.
You can mitigate this by defining your ideal, acceptable and walk-away positions before any negotiation. This includes your desired ownership percentage, governance rights and any critical protections. You will thank yourself later for not crossing your own boundaries!
Valuation Knowledge
Startups are difficult to value because they are so young. There may be limited trading history and financial statements to act as evidence. There is also no publicly listed stock price to refer to. Founders may have overly-optimistic valuations because their business is their “baby”.
As an investor, arm yourself with knowledge about the different ways to value an early-stage company. Some examples include the Scorecard Method, the Venture Capital (VC) Method and the Discounted Cashflow Analysis (DCF).
Remember that negotiating a lower valuation increases your equity stake, but pushing too hard can damage goodwill.
Liquidation Preferences
It’s easy to get caught up in the “entry” phase of a potential startup investment. However, what is your eventual plan for extracting profit from the venture?
Here, you can plan ahead by deciding upon your liquidation preference, which determines how proceeds from a sale are distributed. Participating preferences (e.g., “1x participating”) allow you to get your investment back plus a share of the remaining proceeds.
Most angels accept a 1x non-participating preference. If you go for this option, make sure this clause is clearly defined and fair.
Board and Governance
What kind of say do you want in the running of the startup as it grows? Early influence in the company’s governance can have a big impact on the startup’s trajectory.
Think carefully beforehand about what sort of rights and authority you want. For instance, do you want a board seat or board observer rights? What sort of voting rights do you want over possible future decisions – e.g. M&A, new share issuance or CEO replacement?
Whilst founders may be protective of control, reasonable governance rights offer you (the investor) greater transparency and protection without undermining their autonomy.
Invitation
Want to speak to us about our early-stage opportunities here at our exclusive investor network? Get in touch today to explore our startup projects here at Bure Valley Group.
