How hard should I fight with my potential investor for the best valuation? I am inclined to take the term sheet offered, but my friend thinks I need to fight as hard as possible for the best terms. Since I am new to business negotiations, is there a book I should read?
I would never counsel anyone to roll over and accept everything offered, but I also think entrepreneurs are rarely as sober as they ought to be in term sheet negotiations. You need to focus on what matters to your ability to create value.
Unlike a transaction where you will never see the other party again, you should approach any investment negotiation as the first significant step in a long relationship, perhaps for 10 years or more. Too many entrepreneurs burn down the relationship before it even begins by savagely fighting over things that either do not matter or which they do not understand are perfectly fair.
Maintaining good will with your investors is important, as you are likely to come nowhere near your usually optimistic projections. An investor still smarting from a thrashing on the first investment terms will have a long memory when you come back for a bridge round or next round of financing. I never begrudge anyone trying to protect legitimate interests, but I have, as an investor, walked away from investment opportunities if I felt the entrepreneur was giving me a preview of a long-term difficult relationship. Remember, Rule No. 2 of venture investment is “No Drama.” (Rule No. 1 is “Make Money,” of course.)
That said, you should always fight about terms that matter and even be prepared to walk away. I once negotiated what became a vicious game of chicken with a prominent VC who wanted my client to uproot and relocate his entire family to Nevada so the VC could enforce a non-compete that would be illegal in California. The client said no and the VC (after lots of epithets and invective) blinked. You should never believe an investor is truly your friend (and never fall for the trap of using the VC’s recommended attorney), but top investors also understand the value of a long-term relationship, which is often why they are the top investors getting the best deals.
On valuation, be thoughtful about the actual risk profile of your company. Every entrepreneur is convinced he or she is the chosen one, but actuarial tables say otherwise. If VCs cannot make a return that matches other asset classes their limited partners can choose instead, VC funds will cease to exist. Think of your value more as rough justice in a large insurance pool of risk. Ultimately, you can trade all sorts of provisions for a better valuation, like liquidation preference, but you sometimes do yourself a disservice. If you succeed in receiving a nosebleed valuation, you had better justify it, as you will otherwise impair your ability to raise a future round at all, much less on good terms.
The only true check on valuation, or any term for that matter, is to get multiple offers and execute. If you like the investor and believe the fund will add significant value, then the slight extra dilution hit beyond your ideal will be well worth it in the end.
One final point, if you want tips on negotiating, I strongly recommend only one book: Never Split the Difference by Chris Voss, the former lead international kidnapping negotiator for the FBI. The tools work not only for high stakes venture deals, but also for negotiating with your kids. One of the best business (and life) books ever written.