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Venture
Capital Negotiating Issues
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by:
Dave Lavinsky
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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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