April 2015 Cover Stories Educate

5 Legal Takeaways On Negotiating with Investors

Written By: Erica Brown

After countless meetings, networking events, and introductions, you have gained the attention of a serious investor for your tech startup. Careful preparation and negotiation are just a few of the next steps that are critical to your business’s success. In this article, we outline the top five takeaways that entrepreneurs should consider before moving forward (not in any particular order).

1. FIND THE RIGHT LAWYER. Most venture capitalists, angels, and entrepreneurs will give you the same advice. We recommend that you work with a lawyer that is licensed in Florida and knows deals and the respective securities regulations cold. Don’t just hire a lawyer that quotes you the best price and practices general “business law” and gives you a square deal (as Brad Feld says, your wife’s brother’s friend’s neighbor”).

2. NEGOTIATE OUT THE TERM SHEET. The term sheet is going to frame the deal and drive the economics of the transaction. Some key terms to pay attention to are anti-dilution, the optionpool, board composition, and your personal compensation following the deal. We also recommend that you pull in all of your relevant advisors and lawyers at this stage, so you can get the best feedback early in the negotiation process. Additionally, make sure the term sheet is consistent with your prior conversations. Despite the fact that you may be willing to make a concession that is inconsistent with prior conversation, call them out on it.

3. USE INDUSTRY STANDARDS. There are several great resources to use as base documents while negotiating deal documents. If your investor counsel deviates from industry standard, your attorney should run redlines against some open source investment documents, so you can see how your base documents compare against the industry standards. Y-Combinator, Techstars, and the National Venture Capital Association have open sourced some great base documents to provide you and your advisor a reference point.

4. HAVE YOUR COMPANY’S LEGAL DOCUMENTATION IN ORDER. You may recall that we made this point in our April 2014 article in BITHOF titled, “6 Big Legal Mistakes Commonly Made By High Growth Startups.” Many startups make the mistake of not having their legal documents together prior to meeting with the potential investor. This is important because legal due diligence can make or break an investment deal. In addition, legal ambiguities or inconsistencies can only serve to harm you during the negotiation process. Not having your organizational documents in order will probably not kill a deal; however, it will only serve to give you more bargaining power during the negotiation process, because your company’s legal documentation highlights aspects of your company’s overall health and only serves to improve your deal.

5. EVALUATE EACH PROSPECTIVE DEAL’S VALUE (not valuation). Valuation is the negotiation point that will have a clear and immediate effect on founder dilution, so unsurprisingly it tends to get all of the attention. Naturally, if you were to sell your laptop or any simple asset, you would focus exclusively on the price that the seller is paying. Selling part of a company is different. Nevertheless, young entrepreneurs tend to overweight the valuation number and underweight other important deal points (for example, liquidation preference, antidilution protection, pay-to-play, drag along rights, vesting schedules, representations and warranties). Make sure that you and your attorney have compared and contrasted these deal points if you are evaluating multiple deals.

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