Steps to Growth Capital Self-Study GuideStep 8

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

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.

Generally, investors use one of the following exit mechanisms:

• sale of the investor's interest to a third party
  
• sale of your company
  
• buyback agreements
  
• initial public offering
  
• debt repayment

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).

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