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Venture Capital Negotiating Issues
When companies enter into negotiations with venture capital
firms, there are several issues which need to be defined and
agreed upon. This article describes the key issues.
Valuation. Valuation is the most prominent negotiating issues.
Valuation is the price of the company in which the venture
capitalist invests. Valuation determines what percent of the
company the investor is buying for their capital.
Timing of the Investment. Many investors will commit a large
amount of capital, but will contribute that capital to the
companies in installments. Often, these installments are only
made when pre-designated milestones are met. Vesting of
Founders' Stock. Like capital, investors often prefer that stock
is given to company founders and key employees in installments.
This is known as vesting.
Modifying the Management Team. Some investors insist that
additional or substitute management employees be hired
subsequent to their investment. This gives investors additional
security that the company will execute on its business model. An
important issue to negotiate with regards to modifying the
management team is the amount of stock or options that will be
issued to new management team members, as this will dilute the
holdings of the founders.
Employment Agreements with Key Founders. Venture capitalists
typically do not want companies to have employment agreements
that limit the circumstances under which employees can be fired
and/or set compensation and benefits levels that are too high.
Other key employment agreement issues to be negotiated with
venture capitalists include restrictions on post-employment
activities and employee severance payments on termination.
Company Proprietary Rights. If the company has an important
product with intellectual property (IP), investors will want to
ensure that
the company, and not a company employee, owns the
IP. In addition, investors will want to ensure that new
inventions be assigned to the company. To this end, investors
may negotiate that all employees must sign Confidentiality and
Inventions Assignment Agreements. Exit Strategy. Investors are
very focused on how they will "cash out" of their investment. In
this regard, they will negotiate regarding registration rights
(both demand and piggyback); rights to participate in any sale
of stock by the founders (co-sale rights); and possibly a right
to force the company to redeem their stock under certain
conditions.
Lock-Up Rights. Venture capitalists may require a lock-up period
at the term sheet stage. The "lock-up period" is typically a
30-60 day period where the investors have the exclusive right,
but not the obligation, to make the investment. Investors
typically conduct due diligence during this time without fear
that other investors will pre-empt their opportunity to invest
in the company.
Each of these issues are critical when raising venture capital,
since the outcome can significantly impact the success of the
venture and the wealth potential of the company founders and
management team. Because venture capitalists are very
knowledgeable regarding these issues, and have great skill in
negotiating on them, companies who are raising venture capital
should seek advisors who also have this experience and
expertise.
About the author:
GT Business Plans has
developed over 200 business plans for clients that have
collectively raised over $750 million in financing, launched
numerous new product and service lines and gained competitive
advantage and market share. GT Business Plans is the sister site
of GT Venture Capital.
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