Every once in a while there is a highly public kerfuffle among Silicon Valley investors that delivers an important lesson about funding for entrepreneurs. Last week it was Y Combinator founder Paul Graham's leaked email warning start-ups not to take lowball offers from investors--and specifically from Google Ventures.
Graham argued the search giant's VC arm had a habit of only offering money at a valuation about half of what earlier investors had given.
Google Ventures managing partner Bill Maris took exception to the remark in an interview with Business Insider. Graham responded online elsewhere, stating that his main point was about how allowing a lower valuation after bringing in money can anger early investors (generally not a good idea) and possibly create the impression that your company is having trouble. It was a reasonable point.
Then VC and tech blogger Michael Arrington weighed in, calling for a general cooling of unnecessary drama among the people writing about the situation. Aside from the irony of Arrington, who has a considerable dramatic flair, calling for cooler heads, he had a very good point. There is nothing wrong with a VC firm offering whatever it wants, even if the offer seems to be lowballing, and there is nothing wrong with a start-up turning down money when the terms aren't suitable.
The central issue is that investors and young companies are both in business, and treating this business rationally makes the most sense. However, that is sometimes hard to remember, particularly when you're an entrepreneur and worried that a given offer might be the only one you get.
The minute you tell yourself that you have only one choice, you've undercut your ability to negotiate for a more reasonable deal because you'd told yourself there is only one option.
So, the most important rule of negotiating with VCs? You can always say "no."
Think that's pie in the sky? Then go read the VentureBeat story of a start-up CEO who got kicked out of Y Combinator on his first day and then, six months later, landed $1.5 million from Kleiner Perkins.
There's always another choice. But how do you avoid a bad deal? Here are some tips:
- Research venture funding term sheets--the summaries of a potential deal's terms and conditions. That's where you find out what the person with the money wants. Time to become familiar with them, if you're not already. Early-stage tech investor Brad Feld has a great rundown on what you might find in one. You also need to learn about potential traps.
- Feld also suggests knowing what VCs really want. (No, it's not your soul.) They want the rights to invest more money to maintain their share of ownership if things are going well; they want a way to liquidate when things do go poorly, so they get their money first; and they want to know what is actually going on in your company.
- Use a lawyer intimately familiar with the world of funding and research the firm's reputation. The more you know about the people on the other side of the table, the smarter you can be in negotiation.
- As lawyers Harold M. Hoffman and James Blakey put it in a Harvard Business Review article, know the point past which you will not budge. Then you can make trade-offs and fight for the really important points.
And remember, the most important thing in negotiation is the ability to say "no." In negotiation theory it's called BATNA, or best alternative to a negotiated agreement. For more on how to negotiatie, check out this video from with Jason Green, founding partner of Emergence Capital, on Stanford University's Entrepreneurship Corner.