The purpose of negotiation is to obtain improved transaction terms. Although negotiation is commonly thought of as a series of discussions in which each party advocates for its position, the best results often derive from a structured process that forces multiple parties to compete for the deal. Investment bankers are experts at structuring and running such processes in the mergers and acquisitions context. Although investment bankers are not frequently retained for early-stage financing transactions, their structured negotiation techniques can yield good terms from venture and angel investors. Here are some tips for structuring a process for your startup’s next financing:
- Cast a Wide Net. Identify many potential investors that are a good fit for your startup. In assessing fit, consider whether the potential investor is appropriate for your startup’s stage of development, industry, capital requirement and geography. Obtain introductions to the 5-10 best candidates and schedule preliminary meetings.
- Communicate the Process. At the preliminary meeting, inform the investor that you intend to run a competitive process. So long as there is a reasonable alternative for your startup, even if it is to delay or forego the financing, you can create the competitive tension necessary to extract superior terms from an interested investor. Ask the potential investor about its process for assessing opportunities. This allows you to set a reasonable deadline for offers that provides all prospective investors a fair opportunity to participate.
- Invite Preemptive Offers. A structured negotiation process has significant cost. Management will expend substantial hours on a financing transaction that could otherwise be spent advancing the business. A lengthy process also tends to result in higher transaction costs, in part due to the need to evaluate multiple offers. At the preliminary meeting, inform the potential investor that you will cancel the process if you receive a compelling preemptive offer.
- Divide and Conquer. Avoid revealing the identities of other potential investors. If the list is short or the other potential investors are not credible, the competitive tension may be broken. Further, it is not unheard of for the leading investors to act in concert as co-lead investors. Maintain the competitive atmosphere by only asserting that there is competition and a fair process for bidders to extend offers. Once you have identified and agreed to terms with a lead investor, if the round is not oversubscribed, you can return to other bidders and give them an opportunity to participate on the terms negotiated with the lead.
- Set a Deadline for Responses. The preliminary meetings should give you a good idea as to whether, and how many, potential investors are interested in the financing. Ideally, you will have at least two or three prospects who are initiating their own business diligence efforts to assess the opportunity. Based on your understanding of their processes, set and communicate a deadline for offers. Communicate the deadline not just to the strong prospects, but also to other potential investors that were a great fit for your business. Signaling that other investors have initiated their review may be a catalyst for action from those who show hesitancy.
- Ask for a Sweetener. Assess the offers and evaluate the prospective investors. It is likely that you will feel a strong personal connection with one of the bidders. So long as that bidder’s terms are reasonable, let it know that it is the leading candidate. Ask for modest improvements on the terms.
- Don’t Get Greedy. It is unlikely that a small difference in terms will make a material difference in the long-term outcome for your startup. Reach agreement on terms with your lead quickly, even if it means a compromise on some points. It is more important to get back to the job of growing your business!
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