Tips on Negotiating a Termsheet
Last year, OpenTable founder and all-around great guy, Chuck Templeton, asked me to put together a talk on negotiating termsheets for participants in his Impact Engine program. Although Chuck thought he was asking a favor of me, I found the process of organizing my thoughts on negotiating termsheets (and in general) a personally useful exercise. Below is a digest of the talk including some of my tips.
You see, I got a “B” grade in my negotiations class at Chicago Booth. It’s my own fault for not doing a great job on my final paper. The only time I’ve ever tried to discuss a final grade with a professor (in undergrad or grad) was that class, since I figured that a negotiations professor would have no choice but to appreciate a student trying to negotiate a better grade. The professor never responded to my request for a meeting, which branded upon my forehead one of the great tactics in negotiations: don’t negotiate at all. Well that’s why he was the professor and I was the student.
Ever since then, I’ve been trying to make up for my “B” and have given much thought to the many negotiations I’ve been through in the last 13 years (including buying cars). I’ve paid close attention to great negotiators and bad ones.
Sharing these tips may come as a surprise to people — a VC sharing the secrets of negotiating?! But I don’t see it that way. My philosophy is that I want an entrepreneur to understand in detail the deal they are signing up for. Anything different results in disappointment and a bad partnership eventually. A good negotiator on the other side will express the principles behind their goals (not positions) and we can get to a solution (or not) quickly. Bad negotiators hide their true intentions, obfuscate and confuse, which makes it much harder for the other party to fashion an agreement that satisfies the counterparty. It’s like refusing to tell your spouse what types of gifts you would like for the holidays — you are less likely to be happy with the outcome, or worse yet maybe you won’t get a gift at all!
Not all negotiation tactics/strategies are applicable for all situations. And the approach you use will also depend on your personality and style. It will also depend on your business. For example, distressed investors negotiate with the power and asymmetric leverage of certain doom as an alternative to their deal. Yet a different approach is required for the president of the tiny country of Maldives trying to convince world powers to stem global warming (see the film The Island President in my list of documentaries). So this advice below is applicable in situations where there is balanced leverage.
I like to approach negotiating and a problem solving exercise. I find that makes it less confrontational and less uncomfortable for everyone. When I was negotiating the Base CRM investment, Uzi and I sat at a Carribou Coffee on Clark Street with the cap table in front of us on one computer, and we would just change the numbers together to find something that was fair, Excel goal seek be damned.
Here are some of my observations from great negotiators over the years:
Some of these are worth highlighting. Finding “trades” is a great one that you learn playing Monopoly. When two people assign different values to items in a negotiation, there arises a great opportunity to trade. Without Park Place, Boardwalk isn’t as valuable to you as it is to the owner of Park Place. And if that owner has a property you need to complete a monopoly, that they in turn value differently than you do, there’s a good chance for a deal. This is a great example of how negotiation can create net value — both sides gain. This is opposed to value-claiming, when creativity doesn’t result in more total value- it’s just a land-grab for the existing value. Given the endless customization of termsheets, there usually lies opportunity to create value for those who are creative. So when in a negotiation and there is disagreement about what terms are important, that’s generally great news!
Seeking fair deals may also surprise some as a tip. I’ve seen countless examples of deals that were funded with unfair terms in earlier rounds. Regardless of which side “won” the negotiation, it winds up biting in later rounds, especially as one side feels scorned.
And in contrast, here are some of the mistakes I’ve seen lousy negotiators make:
There is one mistake I’ve seen a lot of entrepreneurs make that ultimately costs them: singular focus on valuation. The truth is that economic value in a termsheet is a function of many terms: pre-money valuation, liquidation preference, size of the option pool, if the option pool is pre or post money, warrants, anti-dilution provisions, dividends, etc. Good negotiators treat all of these as a package. And while each of these economic terms have different magnitude and behavior (some are a function of time, some emphasize downside others upside, likelihood of being negotiated away), they all play a part in the overall economic outcome for a founder. I understand that it’s more impressive to the market to have a big valuation, and no one is going to write a blog post highlighting your small, post-money option pool. It’s just not as exciting. But if all of the PR and personal pride is at the expense of all the other economic terms, that ability to brag has a real cost to it. Per-money valuation is like the MSRP of a car — every educated person knows that’s not what it’s really worth, and that there are a lot of factors that determine the true value.
So good luck on whatever you are negotiating. And here’s to hoping that my former professor reads this post….