I’ve written previously about our experience this year raising a $25M Series C round of venture financing. Venture Diaries: Part One discusses why you want to think before you act and investigate who to target as potential investor partners. Venture Diaries: Part Two looks at how to perform your investigation. In this third part, I look at how to handle the horse race that inevitably develops once you get a few term sheets.
For me it all started when the first term sheet came in. Funny how some VCs still use fax machines. I had to go figure out where ours was. In the current seller’s environment (yes that’s what you are, a seller of equity in your company) one thing to keep in mind is your first term sheet will just be a starting point. Expect that it will probably be lower (perhaps significantly lower) than where you want to end up. Also expect once the first term sheet comes in things will really start to heat up. Nobody wants to miss out on a good investment and VCs are just egotistical enough to really help your cause. However, you should realize each VC has their own style. Some will try to move first in hopes of stealing the deal from others. Others will try to wait till the end and trump any offer — figuring the last hand in has the best chance.
This is where the entrepreneur’s job gets difficult. You want to put everyone on notice that you have a term sheet. This way things really get moving and you can quickly figure out who is really interested and who is just playing along. But what process should you use? How do you maintain your integrity when everyone is asking you for information.
The analogy of selling a home comes to mind. Some sellers will run a sealed bid process. “All offers are due on Tuesday by 5pm and the top offer wins.” This tends to work better in real estate because you already have an asking price. Buyers know what minimum price you expect. In addition, most markets have an established bid/ask ratio where homes get sold (unless your in a rapidly declining or accelerating market which isn’t often the case).
When you’re selling equity in your company to venture capitalists the number one rule is don’t, under and circumstances signal an asking price.
You will get hammered by investors wanting to know what your expectation is for your company’s valuation. There is one and only one correct way to answer this question every time. “We believe we’ve made significant progress since the last round, but the market will price the deal.” This way you signal you’re expecting a nice increase over the last round price but you don’t set a ceiling on this round’s price. Trust me they will all ask you over and over and over again, but don’t give in!
|Back to process. Sealed bidding doesn’t work. So what does? I call it the Road Runner strategy. Remember how the Road Runner used to always chase Wile E. Coyote to the edge of the cliff and then watch him fall off?|
This is what you need to do with each of your potential investors. To maximize your terms and perhaps most importantly figure out what it will be like to work with each of the potential VCs you have to push them to the edge of their comfort zone. While sometimes uncomfortable the process will show you what your potential new board member and investor is really like. Chances are the way they handle a competitive negotiation is the same way they’ll handle themselves in difficult board meetings.
Start out by telegraphing the fact that you have a term sheet to the other investors looking at your company. Be careful not to disclose any of the terms, but tell them it is a competitive offer. If the terms are clean, telegraph that as well. In my case I found it helpful at this point to set a deadline a week or two out whereby everyone must wrap up their due diligence and get you a term sheet. It’s actually a good idea to have a soft deadline communicated in your first meeting with each investor. This way nobody is surprised when you reinforce the deadline. You’re deadline will be soft, but make it seem firm without being pushy.
This is the point where you need to be in constant communication with each interested investor. Return phone calls and emails within an hour. Make sure everyone knows you are available to get them any information they need.
Chances are the VCs will really start selling you at this point. Remember all those tricks Wile E. Coyote had? Most of them some type of Rube Goldberg device manufactured by Acme Corporation. Like the Coyote’s tricks, most of the VC’s points about why they’re the best are somewhat fictitious and sometimes totally outlandish. But none the less they’ll try. You’ll hear all sorts of stories about why you should take a lower offer and how each investor needs to own a certain portion of your company in order to dedicate the time to sitting on your board. Listen attentively, thank them all and then remind them of the deadline and ask them to make their best offer.