Negotiation Per Round: Strategy to Keep Track
“During a negotiation, it would be wise not to take anything personally. If you leave personalities out of it, you will be able to see opportunities more objectively.” — Brian Koslow (founder and president/CEO of Breakthrough Coaching)
In the Venture Capital world there are multiple types of investors that invest in startups in multiple rounds of investment. Investors include independent Venture Capital funds, family offices, corporates, multinationals, among others. For example, the IFC invests in developing country startups that are creating new markets, transforming industries, and driving inclusive growth while realizing strong returns. Among the companies IFC has invested in are Moove (August 2021, debt), Crehana (December 2020, Series A), Trade Depot (July 2020, Series B), Liftit (February 2019, Series A, July 2020, Series B), Moni (September 2018, Seed).
Each round of capital raising involves a negotiation of the terms and conditions and this is different according to the investor profile. In every negotiation, investors and entrepreneurs discuss economic and control elements.
1. Economic: Represented by the contractual terms that may have an economic impact on the investment.
a. Valuation: The economic value of the startup is defined. It is represented by the pre-money value, which is the value of the startup before the equity investment, and the post-money value after the transaction. Entrepreneurs tend to look for the highest value; however, the goal is to arrive at the right value according to the round you are in and the traction you have. What no one is looking for is to have a valuation today and then have a lower valuation in the next round.
b. Shareholding: This is the percentage of the total shares held by each of the parties. Venture Capital investors are not usually looking for majority stakes, but rather to have a significant minority percentage with robust rights.
c. Right of First Offer (Pro-rata): Startups raise capital on a continuous basis. In order not to be diluted, investors seek to have the right to invest an additional amount to preserve the current percentage of equity ownership (pro-rata).
d. Anti-dilution: This is the right that protects investors in down-rounds to preserve the percentage shareholding without the need to invest an additional amount.
e. Liquidation right: In order to ensure a return to investors in the event of exits and to recover their investment before the founders, a preference is established over other investors in relation to the amount invested. Typically, the liquidation right is 1x.
f. Dividends: In the event of a possible distribution of dividends, the leading investors determine a rate that they should receive before the founders and other investors.
g. Option pool: This is the percentage of shareholding reserved for distribution to other relevant employees of the startup and potential advisors. Typically set at 10% in Series A and recalculated in subsequent rounds.
Beyond economic rights, control rights are sometimes more relevant to guiding business strategy.
2. Control: Represented by contractual terms that can have an impact on the organization’s decision-making.
a. Voting rights: Determines the investor’s power to vote and influence corporate decisions.
b. Board seat: Lead investors often have representation on the board of directors along with the founding team group. Occasionally some investors are appointed as observer directors with access to board discussion.
c. Information rights: Investors have access to financial and operational information about the company on a recurring basis.
d. Visitation rights: The right conferred on investors to have access to the company’s facilities and operations at any time upon prior notice.
e. Drag along / tag along: When there is a possibility of sale by the investor or the intention to purchase by a third party, these rights facilitate the execution of such a mechanism.
It is important to note that generally the founders will have common shares and the rest of the investors will have preferred shares. In addition, the lead investors in the round usually have greater rights than the rest of the investors who entered in previous rounds. Those who are angel investors should keep in mind that as the company raises more capital, they will have less preponderance in the startup.
Remember that in each round the lead investor leads the negotiation of the terms and conditions, and the other investors will have to adhere to them. In addition, the corporate documents will define the role of the Major Investor, who will be the investor with the most rights in the startup.
Each investor is unique and has different objectives. Consider whether as an entrepreneur you are receiving investment from an independent Venture Capital fund, a corporate, or a multinational. The approach, terms and timing of the negotiation will be different for each. Be careful who you give control of your startup to and at what cost.
“As you’ll learn, there really are only two key things that matter in the actual term sheet negotiation — economics and control.” ― Brad Feld, Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist
Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.
Gonzalo Soriano. VC Investor at ACV.
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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