Key Takeaways

  • Know your leverage by securing multiple investor options and understanding the investor’s priorities.
  • Build trust through transparency, clear communication, and demonstrating reliability.
  • Focus on long-term value beyond just valuation, including strategic alignment and investor expertise.
  • Prepare thoroughly by understanding term sheets, key deal terms, and exit strategies.
  • Know common negotiation mistakes to avoid, such as focusing only on valuation or failing to understand dilution.
  • Tailor your pitch by understanding different investor types and aligning your approach accordingly.
  • Timing and control of the fundraising process are critical to maintain momentum and avoid desperation.

To understand how to negotiate with VCs, or venture capitalists, you need to understand the leverage you have, create a good level of trust, focus on value, and make sure both parties are on the same page.

Understand Your Leverage

If an individual can gain a good understanding of their power in a business relationship, they can avoid ending up in situations that make them weak. When negotiators focus on the wrong aspects of a deal, they might quickly end up in bad situations that hurt their ability to get what they want.

Having desirable alternatives to your deal is an easy and simple way to give yourself an edge. When a startup, or business venture, is looking for venture capitalists to invest in the business, the more the better. If you have several backups to take the place of one deal, the other party knows that they could lose your interest if they don't agree to your terms. Appearing desperate is the worst position to have in a negotiation.

While it's good to have options and leverage, be careful about the amount of investments you take on. Sometimes, business owners can get a little too trusting in their vision for the company and not accurately assess their burn rate. If you run out of cash during the beginning of your business, you quickly lose leverage and value. When entrepreneurs give up too much equity right away and burn through their capital, they get stuck and may end up taking on a bad investor.

Another great way to obtain good leverage in a deal is by having a thorough understanding of the needs and interests of the other party involved in the negotiation. Ask yourself what they care about or hope for. Are there certain issues or aspects that worry them? If you know the other party well, you can know how to play to their interests.

Understand the Investor’s Perspective

To successfully negotiate with investors, it's essential to understand their objectives and concerns. Venture capitalists and other investors are not only seeking returns—they also want to ensure that founders are capable of executing their vision. Consider the following factors that influence an investor’s decision-making:

  • Risk Assessment: Investors assess how risky your venture is compared to their portfolio expectations. Demonstrating traction, a strong business model, and a capable team helps reduce perceived risk.
  • Return on Investment (ROI): Show how your business will generate significant returns. Use realistic projections backed by data.
  • Exit Opportunities: Be prepared to discuss your exit strategy. Whether it's an acquisition or IPO, investors want to know how and when they can realize their returns.
  • Market Opportunity: Highlight a sizable, scalable market that aligns with investor interests.

Build Trust

When starting a relationship between your business and a venture capitalist, you must recognize that you're both looking at a potentially long-term business relationship. Being able to trust each other is important. VCs only want to associate with businesses that they trust and believe it, so be careful to show yourself and your business as stable and trustworthy.

If you're negotiating with a more vulnerable venture capitalist, be reliable and upstanding rather than using their weakness to take advantage of them. A trustworthy business relationship is a healthy one that can only help the business grow and succeed.

Prepare and Communicate Clearly

Preparation is key to building investor confidence. Before entering negotiations:

  • Know Your Numbers: Have a solid grasp of your financial statements, projections, burn rate, and runway.
  • Create a Data Room: Prepare an organized set of documents, including your business plan, pitch deck, cap table, and legal documents.
  • Practice Your Pitch: Ensure your pitch is concise, compelling, and adaptable for different investor audiences.
  • Be Transparent About Risks: Acknowledging risks shows maturity and honesty. Present mitigation strategies for key risks.

Focus on Value Instead of Only Valuation

Money is only one part of the negotiation puzzle. There are other aspects of an investor relationship that are valuable rather than just the monetary value of the business or shares. Many venture capitalists are not solely interested in shares and benefiting from the profits of a business. If you are seeking investors, you'll likely need to give up some control.

Business owners can end up in a tough position when trying to raise startup money. They need the money to run the business, but it comes at a cost. Usually, investors will agree to give a certain amount of money for a certain amount of control. A business owner will likely need to trade shareholder voting rights and other forms of influence in the company in return for cash.

Understand Term Sheets and Key Deal Terms

Valuation is just one part of the negotiation process. A clear understanding of term sheets and common deal terms is crucial for protecting your interests. Key terms to focus on include:

  • Liquidation Preferences: Defines who gets paid first in an exit scenario.
  • Anti-Dilution Provisions: Protects investors from dilution if new shares are issued at a lower valuation.
  • Board Composition: Determines who has decision-making power at the board level.
  • Voting Rights: Clarifies the extent of investor control in company decisions.
  • Vesting Schedules: Especially relevant for founders' equity and retention incentives.

Always consult with an attorney or financial advisor to fully understand the implications of these terms before signing any agreement.

Things to Keep in Mind When Negotiating With a Venture Capitalist

There are a few other tips to keep in mind as you negotiate with venture capitalists to try to grow your business. These include:

  • Getting the most out of the terms and conditions of your agreement.
  • Hiring an experienced business lawyer to help with negotiations.
  • Keep track of preferred and common stock and their differences.

Some say that the terms of an investment contract aren't a big deal, but this attitude to easily lead to a bad agreement for the business. You want to make sure that the terms are in the best interest of your business before you sign. This is hard, especially if a venture capitalist is ready to invest a lot of money in your venture, but unfair terms can come back to bite you down the road.

Avoid Common Negotiation Mistakes

When learning how to negotiate with investors, avoid these frequent pitfalls:

  • Focusing Only on Valuation: Overemphasizing valuation may lead to poor deal structures or unfavorable terms.
  • Failing to Build Relationships: Investors prefer to back founders they trust and respect. Networking and relationship-building should start well before funding discussions.
  • Ignoring Dilution Impact: Understand how each funding round affects your ownership stake and decision-making control.
  • Lack of Preparation: Entering negotiations without clear financials, metrics, and strategic goals reduces your credibility.
  • Agreeing to Unfavorable Terms Due to Desperation: Maintain discipline even if funding is critical. Bad terms can have long-term consequences for your business.

Tailor Your Approach to Investor Types

Different types of investors may have varying expectations and negotiation styles. Tailor your strategy depending on the type of investor:

  • Angel Investors: Often value personal relationships and vision alignment over hard metrics.
  • Venture Capital Firms: Typically focus on growth potential, scalability, and exit strategies.
  • Corporate Venture Arms: May prioritize strategic fit and alignment with their broader business objectives.
  • Private Equity Firms: Tend to look for established businesses with predictable cash flows.

Understanding the specific goals of your investor type helps you position your negotiation more effectively.

Control the Fundraising Process

Managing the fundraising process effectively can increase your negotiating power:

  • Set a Timeline: Define clear fundraising deadlines to create urgency.
  • Control the Narrative: Keep communication consistent across all potential investors to prevent misunderstandings.
  • Avoid Overexposure: Sharing sensitive details too early or with too many parties can weaken your negotiating position.
  • Leverage Investor Interest: Use momentum from multiple interested investors to strengthen your position in negotiations.

Frequently Asked Questions

  1. What should I focus on first when negotiating with investors?
    Start by understanding your leverage and the investor's perspective. Know your financials, market opportunity, and prepare to articulate your long-term vision clearly.
  2. How important is valuation when negotiating with investors?
    Valuation is important but should not be your sole focus. Deal terms, investor alignment, and long-term growth potential can be just as critical to your success.
  3. What are the most common mistakes founders make in investor negotiations?
    Common mistakes include focusing only on valuation, failing to understand deal terms, neglecting relationship-building, and underestimating the impact of dilution.
  4. How can I improve my leverage in negotiations?
    You can improve leverage by securing multiple funding options, demonstrating strong traction, understanding investor priorities, and being well-prepared with your financials.
  5. Should I work with a lawyer when negotiating with investors?
    Yes, working with an experienced business attorney ensures you understand complex deal terms and avoid agreeing to conditions that could harm your company’s future.

If you need help with understanding how to negotiate with investors, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.