How can you negotiate VC funding without giving up too much equity?

Evolving valuation landscape: Explore emerging valuation trends, such as the increasing use of non-financial metrics (e.g., customer engagement, social impact) and the impact of artificial intelligence on valuation models. Global valuation factors: Discuss how factors like geopolitical risks, regulatory environments, and cultural preferences influence startup valuations across different regions. Subjectivity in valuation: Acknowledge the inherent subjectivity in startup valuations, as they often rely on future projections and market potential rather than solely on tangible assets. Caution against the risks of overvaluation, which can lead to unrealistic expectations and potential challenges in future funding rounds.

My rule of thumb (for early stages): - Founders give away 15-25 % of equity per round - A financing round should provide runway for about 12-24 months to reach the next value inflection point - Buffer needs to be allocated as it always takes longer than planned (including the fundraising)

Adopting the right business model for your product can increase your valuation. For instance, "Software as a Service" companies are valued higher than "Software as a Product" company because a subscription model makes your product more affordable for a larger customer base. Therefore a SaaS valuation is a multiple of your Annual Recurring Revenue, while a product valuation is a grey area based on perceived intellectual property value of your software.

In VCism, where 'trends' often dictate 'transcends', this introduction to startup valuation overlooks the cutting-edge market dynamics. Say, "Innovation loves constraint, and constraint breeds creativity." I can say, that valuation is art, not science. Startups should value themselves on their capacity to disrupt, flexibility to fast-changing contexts, and cultural effect, as well as sales and cash flow. In this fast-changing world, an unusual valuation method that includes these qualitative factors can be more insightful. The market wants innovative businesses. Let's build and tell value, not just quantify it. So fold wisely, aim high, and let your vision guide valuation. Bold ideas typically pay off in startup ecosystems.

Everybody here has good points, but I want to add something that is all-so-frequently missed by founders, and also by investors. Your valuation should also be tied to what you actually need to reach your next viable milestone. That milestone should be in a "plannable" future - 12-24 months ideally. So track back expenses you need to get there, add in a 25-40% buffer for unknowns, and divide by ave equity given away for your round. This is bottom up valuation - which should be matched to top down industry standards. All too often founders throw out a number that isn't realistic - and then they trapped being over/under valued in the next round.

I'd like to highlight the strategic aspect of valuation during fundraising. Founders should not only focus on the highest possible valuation but also consider the value-add of investors. A strategic investor who offers industry connections, expertise, and growth support can be more beneficial in the long term than a higher valuation that comes with less strategic value.

This is the starting point. Because in an ideal world, you would get LOTS of investment for LITTLE dilution. But this is the real world...the VC world...and that won't happen. Now valuation is like asking 5 economists about what's going to happen in 2024: You will get 5 different answers. There are many ways to do valuations. But remember at the end of the day value is what someone is willing to pay and what you are willing to sell for. So it's an art and a science.

I would focus on several key steps: - Know Your Valuation: Understand your company's worth to determine reasonable equity to offer. - Choose the Right Investors: Select investors who offer more than money, like expertise and connections. - Understand the Term Sheet: Be clear about terms like valuation, equity, voting rights, and liquidation preferences. - Be Flexible and Creative: Consider alternative deal structures, like convertible notes or different classes of shares. - Plan for the Future: Anticipate future funding rounds and how they will dilute your equity.

The right investors won't try to take too much equity as they know you'll likely raise future rounds. For first rounds of financing, you should give up between 5-20%. Giving away more than that can be damaging to your captable. The right investors will also bring not only capital but a network and trove of experience to help your startup grow rapidly in the early stages. Also find investors that complement your weaknesses.

Investor types and their roles: Differentiate between angel investors, venture capitalists, corporate venture arms, and other investor types, highlighting their unique strengths and investment approaches. Potential biases: Acknowledge potential biases in investor selection, such as prioritizing known investors or those with a certain reputation, and encourage founders to evaluate all options objectively. Negotiating terms: Share strategies for negotiating favorable investment terms that protect founders' interests and align with long-term goals. Emerging investor trends: Explore trends like impact investing, crowdfunding, and the rise of solo capitalists, and their potential impact on startup funding landscapes.

Not all investors are created equal. And I typically advice clients that if you don't want to be stuck in an elevator with them for 1 hour, probably not the right investor for you from a interpersonal standpoint. Money isn't everything (although I understand as a Founder raising capital that's hard to see). Just like investors are interviewing you, do the same. You don't HAVE to accept anyone's money. This is a partnership. Do your own due diligence to make sure this is someone you can and should work with. It will make the negotiations much easier.

When selecting investors, I would advise startups to prioritize strategic alignment and value addition over mere capital. Different investor types, like angel investors and VCs, offer distinct benefits beyond funding, including mentorship and industry connections. It's crucial to conduct thorough due diligence on potential investors, assessing their track record, portfolio, and alignment with the startup's vision. Founders should also be aware of biases in investor selection and focus on objective evaluation. In negotiations, it's not just about the valuation but also the terms that align with long-term goals. Emerging trends like impact investing and crowdfunding present new avenues, especially for startups with social impact objectives.

Investors come in all flavors. Many will say that they want to invest in the right people or team. But actions speak louder than words. If they try to nickel and dime every basis point of equity, they're probably the wrong people for you. Whenever negotiating, think about the entire term-sheet holistically. It is ok to be flexible so long as your interests are not decimated. For e.g., they want more equity, but can they show some flexibility on the option pools? If seeking early investments through instruments like SAFEs, can they agree to a valuation cap that ensures that founders still have enough skin in the game? Have meaningful conversations and don't hesitate to ask tough questions. The right people always reveal themselves!

Indeed, not every investment is the same, but let's do it the other way around. There's more to it than their money or reputation. The way they make you feel! In what way do they relate to your startup? Are they compatible with your upsetting energy? Choose buyers who are more than just rich people in a world where a tweet can change the way the market moves. Keep an eye out for people who can make things go viral on Twitter and who know that a meme can be worth a thousand talks these days. Do not forget, nowadays, it's not so much about their business as it is about their meme portfolio. Therefore, choose partners who will not only give you money but also help your business grow. You're not just working; it's a huge journey!

I will add one thing - know which are the WRONG investors :). Investors that put their money/ego primary to the future of the company are a RED FLAG. I have also had questionable experiences with investors pushing for Post-Value safes... these are tricky mechanisms that have sometimes serious consequences for next rounds...

Well....... As an attorney, you KNOW this is important. And if you don't understand the term sheet, ASK. SOMEONE. before you sign. Even though term sheets tend to be less legally binding, you don't want to appear that you don't know what you are doing.

The term sheet's role has evolved from a mere transactional document to a strategic tool in deal-making. It's crucial for founders to understand how term sheet clauses like liquidation preferences can affect their returns. For instance, a 2x liquidation preference means investors get paid twice their investment before others receive any payout in a liquidation event, which can significantly dilute the payout to other shareholders. The terms can change during subsequent funding rounds. For example, terms agreed upon in early rounds might be renegotiated in later rounds, impacting earlier investors and founders differently.

In term sheet negotiations, founders should balance investor interests with safeguarding their rights and future growth prospects. Clauses like drag-along and tag-along rights are vital; drag-along rights allow majority shareholders to force minority shareholders to join in the sale of a company, while tag-along rights enable minority shareholders to join a sale. These can impact control and exit scenarios. It's essential for founders to understand these terms' implications and seek flexible conditions that accommodate future changes and investment rounds.

Yes, VC's holy book is the term sheet. Don't treat it like a dusty old book in 2024. Remember, "X" represents where creativity meets cash on your treasure map. Each clause? Riddle to solve. Board seats, equity, valuation? These are chapters of your startup's amazing adventure, not figures and titles. Imagine playing chess with your investor—every move matters. The term sheet is about creating a story where both sides are heroes, not simply equality and control. Startups are the new rock bands, thus your term sheet is your setlist. Work with your lawyer and accountant to ensure your term sheet is in tune. Remember, you're sealing a deal and opening the future. Go go go, startup fighters!

One of the less commonly used mechanisms for Founders to reduce dilution is to create a meaningful ESOP prior to VC funding. That's because in an equity financing, VCs will ask for the creation of an ESOP and define it on a pre-money basis. The 'harshest' structure looks like this: Startup X is raises $2MN @ $10 MN pre-money with a 20% ESOP on a pre-money basis. This ACTUALLY MEANS: $8 MN effective valuation + $2 MN option pool. Creating the ESOP proactively dilutes Founders but it can help Founders avoid further expansion in an equity round financing. i.e. having a 10 of 15% pool already in place helps you negotiate against a VC impose the largest possible ESOP pool, say 20% pre-money. That equity value directly benefits Founders.

In VC negotiations, founders should strategically leverage non-financial assets. This includes highlighting unique aspects like proprietary technology, market positioning, or team expertise. These assets can be pivotal in balancing power dynamics, especially for startups facing seasoned investors. Additionally, founders should explore creative solutions like milestone-based funding, which aligns investor support with business progress, ensuring a fair and growth-oriented investment approach.

Venture capital negotiations have evolved to encompass more than just financial terms. Founders are increasingly valuing strategic support, network access, and expertise that investors bring. The focus is shifting toward long-term growth potential rather than immediate financial gains. We must address the potential power imbalances between startups and seasoned investors. This imbalance can sometimes limit a startup's negotiation leverage.

At the end of the day, if a VC is approaching you, they want a deal. So you have to give a little and they do. Sometimes that involves getting REALLY creative (while staying legal and ethical.) I have seen it all but it got the job done. And all of this is contingent on valuation, the right investor and understanding the term sheet. A good negotiation, by my definition, is when "both parties leave the deal a little unhappy." Yeah that's the pessimistic lawyer talking but it's true. You can't have it all. You sacrifice, they sacrifice, deals are made.

in my humble opinion: "It's not about slicing the pie into smaller pieces, but baking a bigger pie together." Old zero-sum game? Outdated! Today's symphony has investors and entrepreneurs as composers. Flexibility? Absolutely. Call it'strategic choreography.' You're not just juggling numbers—you're creating art. From value to board seats, each term is a dance move. The key? Know when to lead and follow. Your moonwalk move may be a lower valuation with significant revenue potential. Sometimes your tango twist is keeping that board seat. Remember that the final agreement is a performance when both parties bow. Keep your main concepts as your rhythm and bargain like a pro. Let VC funding be the future dance!

I helped a fintech startup, secured a $10 million Series A funding at a $40 million valuation. Post-funding, they focused on: Milestones: Achieving user growth targets of 50% year-over-year and revenue milestones agreed upon with investors. Exit Strategy: Exploring future IPO possibilities while keeping options open for acquisition by larger financial institutions. Investor Alignment: Conducting bi-monthly meetings to ensure strategic alignment and transparent communication, adjusting strategies as market conditions changed. Future Funding Preparation: Planning to use growth metrics and market traction to argue for a higher valuation in the next funding round. A startup can utilize VC funding as a foundation for long-term growth.

Investor Relations is a REQUIRED part of my clients journey with us. Taking VC money only BEGINS the long 7-10 year relationship with that investor. It is NOT the end as some founders think it is. So come up with a plan that answers how and what and when and who your relationship with your investors will be even before you raise your first dollar. Planning prevents problems.

Getting VC funding is the first step in the journey of your business, not the last. It's kind of like taking off on a space journey with your investors. Focus on big goals like faraway stars and find your way to them. It's not enough to fuel your rocket; you need to plan a path through uncharted areas of growth and opportunity. Your relationships with investors are like the controls for your spaceship. Be clear, make sure you both have the same goals and remember that every choice you make affects the path of your startup's journey. Let's not just fly; let's soar into the business of deep blue! As I said in my book, "Put a shark in your tank, and see how fast you can swim!"

The experiences of 2022 and 2023 taught me about brutal changes in market conditions, so when planning for future funding and exit strategies, startups should consider alternative scenarios for shifts in the market or internal dynamics. They need contingency plans for slower growth or pivoting their business model. Actively managing investor relationships beyond formal meetings, like through regular updates or seeking strategic advice, strengthens partnerships and provides insights for navigating challenges and seizing opportunities.

There is one of the best framework which could be really helpful for any negotiation. Value Creation versus Value Extraction. While preparing the business plan a founder should project how much capital would be required for immediate 18 months, 36 months and 60 months. With required capital infusion, what value would be generated. Then there should be a definite plan for value extraction at each level. Someone who is able to portray long term value creation can convience investors about the long term value extraction. Thus a founder get in strong position of negotiation.

I heart startup finance :). I want to add one thing for early and very early stage... relevant to founders and investors. --> Understand the strategic play behind a Note, a Pre-val Safe and a post-val Safe. None of them are perfect. Understand it from 3 perspectives - founder, investor, next round investor. I have seen deals die because of wonky crap in these mechanisms.

If you want to secure additional capital and you have demand for it you can always try to push additional "late" investors into a SAFE and "gain" some equity back by pushing them to the next valuation. Obviously this assumes that your next valuation will be higher. Sometimes, it can be tricky to set a milestone that doesn't distort your efforts but, you can have a milestone based investment whereby you have the investor put more money at a higher valuation if you hit a specific milestones. The VC gets the benefit of delaying part of the investment and make contingent upon certain achievements. Of course, this is easier said than done because the VCs may not be up for it.

A founder only gets to negotiate marginally (terms/valuation/fund ) when the demand (Vc interest i.e term sheet) is more than the supply (stock dilution in a round).

Negotiations are key and should be uncomfortable. In a good negotiation both parties win. It’s a give get throughout and even sweating the small stuff can be important. Think about how you are perceived. VC will go through their DD but if you just do exactly what they say when they say it, you most likely won’t be viewed in a high status by the investor. Sweat the small stuff and negotiate. The point is not to be difficult but to get to a win win.

I believe that serious VCs can and are considering a healthy future for the venture and its leading founders. That's a great angle to highlight when negotiating the investment terms.

Entrepreneurs should also figure out exactly how much money they need. Once investors show interest, there's some room to negotiate this amount, but it's important to understand the implications: - Opting for a larger sum can extend the runway and allow more room for errors. However, this leads to increased dilution and puts greater pressure on the company to achieve high valuations for a successful exit (a larger round means that the investors are buying in at a higher valuation and would expect a higher exit valuation to achieve their desired returns). - On the other hand, raising a lower amount limits dilution and reduces the pressure on the company to reach extreme valuations for a successful exit.

In any negotiation, it's crucial to build leverage through domain authority in your business i.e. KNOWLEDGE. Let me give you my example: VCs often catch you with the tricky question of Total Addressable Market (TAM), which is only as big as the founder believes it to be. What has helped me turn this tricky question into my strong suit is redirecting it to something I can answer more confidently: Serviceable Available Market (SAM) and Serviceable Obtainable Market (SOM). No matter what the TAM might be, if we have the best SAM and SOM projections and present them well to the VCs, you are most probably going to lose less equity. Note: This approach tends to work better in normal fundraising situations than in strategic partnerships.