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8.3 What's on the Table
Negotiations can be lengthy and complex, so it's important to keep in sight
the main issues that are under negotiation:
- Price. What is the business, and the opportunity,
worth? And how much will the investor pay in exchange for a share
of the business?
- Control. How much of the company will the
investor acquire? What powers and responsibilities will the investor
get, and how will they be exercised?
- Performance Measures. How will you, and
the investor, know if your efforts are successful? What measures and
targets will you use?
- Exit Strategy. From the investor's perspective:
How can the investor get his or her money and profit out of the business?
From your perspective: What's your strategy, over the long run, for
ownership, financing, and operations?
- Employment Contracts. Will key employees
be contracted to be sure they keep their positions?
Price
Price is a complex issue, based on the valuation of your business.
Ultimately, the market determines the price of your opportunity, but
the market is hammered out during the negotiation. You have to have
a good idea of the range of values that you are prepared to accept,
and the values that the investor may be considering. For more on price
in negotiation, see Arriving at a Price. (Also,
see Step 3 of this Guide for more on business
valuation.)
Control
Key Questions
Ask Yourself:
Do you want to own 70% of a potentially bigger company in five years,
or 100% of a much smaller company that may not be able to grow?
Until now, you've probably enjoyed 100% control over your business.
You've made all the decisions to invest in equipment, lease new premises,
develop new products, set budgets, etc. Relinquishing part of this control
may be the hardest issue to resolve in your own mind.
Remember that most investors aren't looking to gain control of your
business. Most don't have the time to run all the companies they invest
in. What they do want is to receive an acceptable rate of return while
limiting their risk. They have several ways to limit their risk and
impose some control:
- Requiring consultation or imposing restrictions on future decisions.
They may demand consultation before you raise additional debt equity,
make capital expenditures above a certain dollar amount, increase
management salaries, repay shareholder loans, or hire new managers.
- Ensuring representation on the board of directors.
The investor may or may not want a seat on the board depending on factors such
as the relative size of the investment and the current board composition.
While the investor may see board membership as a way to maintain some
control, you should look at it also as an opportunity to add skills
and experience to your company.
- Setting performance-based targets. The agreement may have
terms for adjusting the amount of equity you give up depending on whether or
not you meet specific pre-set targets.
- Demanding anti-dilution provisions. To ensure that the
investor's position is maintained, he or she may ask for a ban on the sale of
additional shares or a provision allowing early investors to participate
in future sales of equity. (Most entrepreneurs prefer the second option
because it gives them flexibility to raise additional capital from new
investors, if necessary.)
Performance Measures
It's important that you and the investor agree on the performance measures
you'll use to determine if your business is succeeding as expected.
Performance measures may include:
- total sales volume targets;
- gross margin dollars and percentage targets;
- net income targets;
- cash flow levels; and
- debt repayment.
These measures of success may be used to determine whether, for example,
you can negotiate an option to buy back equity, or whether you must
give more up.
Exit Strategy
Investors want to know how they will recover their capital, and you
want to be sure the timing accommodates your company's needs. So you'll
have to discuss the when (the optimal term for the investment) and the
how (what is the best method) of the exit strategy. Dissatisfaction
with the exit provision is a key reason why investors turn down proposals. So
you'll want to have feasible alternatives to consider during negotiations.
Take a Closer Look
Exit Options
Both you and the investor have to be happy with the company's long-term
plans. Investors will want to be sure they can get their money out,
and you want to be sure you've got options for the future. There are
a variety of options for the Exit Strategy
Generally, investors use one of the following exit mechanisms:
Employment Contracts
These contracts ensure that key employees keep their positions, as
part of the financing agreement. Legal advice should be sought in drafting
the employment contract. A few common terms of a typical employment
contract are:
- remuneration, including benefits and the form of compensation;
- termination arrangements, including conditions, notice period and
severance;
- conditions attached to the voluntary departure of the individual from your
company;
- a form of "non-compete" contract, which restricts the
individual from starting a similar business or working for a competitor
in close proximity for a specified period of time; and
- ownership of technology or intellectual property (if applicable).
Greed or Ego?
A venture capitalist once told Tony Melli, founder of Bfound.com, that there
are two kinds of successful entrepreneurs: those motivated by ego and those
motivated by greed. The venture capitalist noted that given a choice, he would
much rather invest his money with a greed-driven entrepreneur.
- An entrepreneur who is driven by greed will make the decisions required to
grow the company.
- An entrepreneur who is driven by ego will be so focussed on retaining
control that he or she may not be able to attract growth capital.
Tony and his partners decided early on that they would rather own a portion of
a large, profitable company than be the sole owners of a small company with
limited growth potential. This realization made it easier for the team to
accept relinquishing some control in exchange for growth capital.
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