Negotiating (5th Fundamental of Early-Stage Investing)

Negotiating is perhaps the most romanticized aspect of partaking in an investment opportunity. The idea of meeting room negotiations is widely portrayed as the climax of movies, in TV advertisements, and other media outputs. However, David Amis and Howard Stevenson suggest that it is often the shortest stage because many winning investors simply do not negotiate (p. 225, 2001). On the other hand, they also acknowledge that “Negotiation will almost certainly bring improved terms” (p. 228, 2001). Unlike other fundamentals of early-stage investing, negotiating is not a spectrum of choices. Negotiating starts with a choice between actually negotiating and not negotiating at all. Both are valid options and deserve further analysis to better understand the intricacies of negotiating early-stage investment deals.

Choosing to Not Negotiate…

At a first glance, deciding to not negotiate might seem like a poor choice. However, there are a number of situations where this might be the only or even the best option. The most basic, yet somewhat counterintuitive, reason to not negotiate is if the proposed terms of the deal seem fair. If this is the case, the investor can potentially obtain better terms, but risk souring the relationship with the entrepreneur(s). Another instance in which an investor might not negotiate a deal is when the investor is a late entrant to the investing round. In this case, it is likely that a lead investor has already negotiated reasonable terms and other co-investor and late entrants might not need to (or be able to) negotiate new terms. A third case that might lead to a no negotiation decision is if the valuation and/or terms are outrageously unreasonable. Under this scenario even the best possible outcomes of arduous negotiations might not close the expectations gap; thus, leading to a non-negotiation decision and taking a pass on this deal opportunity. These three examples highlight the complexities of deciding to not negotiate a deal.

Choosing to Negotiate…

According to Amis and Stevenson, if an investor(s) decides to negotiate, it is likely that negotiations will involve one of the following four key areas:

  • The Price
  • The Structure of the deal (terms)
  • How Much Money They Will Invest, and/or
  • What Role They Will Play (If Any).

The intricacies of Price (Valuing) and Terms (Structuring) have been addressed (See prior blog posts); therefore, the other two key areas deserve further analysis. The question regarding the right amount of money to invest is one that can be answered by each investor individually. The response is directly proportional to the investor’s funds and level of confidence in a given investment opportunity.

The fourth key area, The Role Investor Will Play, is probably one of the most abstract. Harvard Business School Professor Deepak Malhotra warns that heated and prolonged negotiation might ultimately yield an agreement, but undercut potential future resources from investors in the form of referrals, mentoring, strategic advice, and other alike resources (Harvard Business Review, 2003). Professor Malhotra’s views seem to echo Amis and Stevenson’s thinking process when they write, “As early-stage investing becomes more and more competitive, having a successful entrepreneur who refers other entrepreneurs and industry people can be beneficial” (p.234, 2001). The common message is to proceed with negotiations, but protect the relationship between investors and entrepreneurs. In other words, the relationship between entrepreneurs and investors should be viewed and treated as a gift that keeps giving.

It is clear that the complexities of negotiating an early-stage investment deal are beyond the scope of this post. However, Professor Malhotra’s article along with David Amis and Howard Stevenson’s book, Winning Angles: The 7 Fundamentals of Early-Stage Investing, are great starting points. Please comment below and link any additional resources helpful in negotiating discussions.

References

Amis, D. & Stevenson, H. (2001). Winning angels: the 7 fundamentals of early stage investing. London: Pearson Education Limited 2001.

Malhotra, D. (2013, May). How to negotiate with vcs. Harvard Business Review. Retrieved from https://hbr.org/2013/05/how-to-negotiate-with-vcs

5 Replies to “Negotiating (5th Fundamental of Early-Stage Investing)”

  1. Jose,

    I found this chapter to have quite a bit of important information. It stated, choosing negotiation is up to the angel. They do not have if they don’t want to. But, digging deeper into, it is clear that a “winning” angel chooses to head in negotiations in order to get a better chance of securing a deal. This puts the entrepreneur in a difficult position, because they are trying to secure investors while trying to keep fair numbers across the board. As a first time entrepreneur heading into this process it must be difficult. I look forward to reading your next post!

    – Paul

  2. I could not help but to laugh as soon as I saw your illustration of the meeting. My first thought was New York City Mafia so when you said “Negotiation will almost certainly bring improved terms”, do you have a choice with this crowd? I know that this image was probably from a movie set but it does portray the thought process of a typical investor or entrepreneur. Both are probably nervous going into the negotiation, and both want good terms, but does one simply cave in and accept the deal on the table? Probably not, but it is likely the simplest result.

  3. Jose,

    I completely agree! I think the picture that you used for this article pretty much sums how we think of negotiating. Hold your ground until the other person folds so you can “win”.

    People think of negotiating in such a transaction manner, they never consider the relationship behind the negotiation. If your negotiating with someone who doing great things, don’t you think you might be negotiating with them in another deal? Why destroy that relationship for a short term win? As long as everyone can come out feeling like they had some sort of win, I think that the negotiation was a success. We all need to start thinking more about the long term, rather than what is going to make us money right now.

    Thank you,
    Tom

  4. Jose,

    I enjoyed reading your thoughts on this section. What I find to be most interesting is the reference you to Deepak Malhortra’s warning about prolonged negotiation. Sometimes too much is too much and it leaves the deal dead in the water. I have to wonder how many investors and entrepreneurs missed out on the deal of a lifetime just because they did not want to budge on the terms of negotiation. Great post!

    Jennifer

Comments are closed.