Negotiations with investors are tough – especially when you’re not accustomed to these kinds of discussions and the party across the table engages in them on a regular basis. What’s the most important advice (right after hiring a good/experienced lawyer who understands your business) – focus on what’s important – economics and control.
Having stated that you must understand and try to aggressively protect, retain and preserve economic/financial upside and control, it’s also essential to understand that the investor has something you need – money – and it’s inherently reasonable for that investor to expect in return for providing you with that money that he or she will receive both (a) substantial economic upside in the event the company is successful and downside protection if it’s not, and (b) a degree of control in order to protect that investment.
Unfortunately, I can’t provide a detailed explanation in a blog post of all of the terms and variables that arise in negotiating economics and control, but here are a few you must understand (Note – if you don’t know what these terms mean, find out before negotiating):
• Valuation – what ownership share will the investor get for invested dollars?
• Dividends – if the investor is to receive dividends, how much, when, who decides, and are they cumulative?
• Preference – assuming the investor gets paid first upon a liquidity event and that payment is more than the initial investment (i.e., a preference), how much more?
• Participation – after receiving the preference, does the investor get to “participate” in the remaining proceeds, and if so, to what extent?
• Dilution – how can various parties be diluted (including by an employee incentive pool), and what impact will this have on distribution of proceeds?
• Board Seats – who fills the Board seats, and what is the “balance of power”?
• Voting Rights and Protective Provisions – what issues does the investor get to vote on and/or veto?
• Conversion Rights – assuming investors receive preferred stock, when can they convert to common, and what impact might that have?
• Tag-Along and Drag-Along – under what circumstances can parties force others to participate in a sale or allow them to participate in a sale?
The above list is, admittedly, abbreviated, but it should give you an idea of the most important issues in negotiating with investors – everything else pales in comparison.