DOs and DON’Ts in negotiations with VC investors
In the context of an equity investment, an investor seeks to maximize the terms of his own involvement in a company, primarily via the parameters of low valuation, assurance of special financial rights, such as liquidation preferences, and special non-monetary rights, such as approval requirements or advisory board seats. Founders naturally seek to optimize their own position primarily by maximizing valuation and limiting co-determination rights.
In practice, it can be observed that in many financing rounds of young, fast-growing companies, there is often one party with a clear preponderance of negotiating power and therefore does not necessarily negotiate with the other side on an “equal footing”. If, however, this bargaining power is exploited too much when establishing the VC participation, which is typically structured as a minority interest, a counteracting effect often occurs and the goal of a balance of interests is missed. The parties fall into a mode of supposed optimization of particular interests, which is seldom to the benefit of the company and, in the end, of all involved. Against this background, both parties should have an interest in agreeing on appropriate, fair and transparent conditions and parameters for a good and professional cooperation from the very beginning.
The core of a successful financing round and often also of successful growth is solid preparation on the part of the company. The valuation is a central parameter for the extent of the investor’s economic participation in the company to be financed. Here, a realistic self-assessment of the founding team is strongly advised. Contractual arrangements should include appropriate monetary privileges for investors. — Milestones can be an important part of a funding agreement as intermediate steps and internal and external checkpoints, and can serve as a useful stock-taking exercise at appropriate times. In addition to special monetary rights, information and co-determination rights are another key element of VC financing. In this area, too, an adequate and balanced structuring of rights can positively accompany the company and promote its development.
Adequate ongoing reporting and up-to-date accounting should be a matter of course. The founders should also leave no doubt about the IP (Intellectual Property) situation of the company from the outset.
Of course, when it comes to the concrete design of the parameters of participation, there are numerous possible designs that vary in detail and are determined by the individual negotiating power and skill, information asymmetry and individual assessments and level of experience of the participants. — The aim should be to implement clear, fair regulations that can also be implemented and are appropriate to the company’s stage of development and that positively accompany the company’s development.