How can you negotiate a term sheet with a VC who wants too much control?

The paramount advantage a founder can wield lies in possessing profound domain knowledge. Not only does this confer significant influence to your position, but it also communicates to a venture capitalist that they require your expertise to manage the business more than you necessitate their financial support.

The BATNA (Best Alternative to a Negotiated Agreement) is a concept that helps you strengthen your negotiating position. It refers to the best alternative you have if you cannot reach an agreement with your negotiating partner. In general, the more Termsheets you have from different investors the easier it will be to negotiate the terms in your favor. If you have only one Termsheet then it's way harder to negotiate. An example of applying BATNA in a negotiation if you only have one Termsheet could be considering another financing option if you cannot agree to the VC’s terms. Start at least 12 months before you run out of money with the preparation of your fundraising round.

Facing a term sheet demanding too much control? Cultivate optionality by engaging multiple investors, especially when one nears a term sheet agreement. This creates a competitive atmosphere, granting you leverage and choices. Actively progress talks with various investors to strengthen your position. This competition encourages better terms from each, ensuring you're not locked into a single option. Such a strategy not only offers a safety net but can also lead to terms that better preserve your company's autonomy, aligning with long-term goals. In VC, multiple offers aren’t just advantageous; they're crucial for a founder's strategic success.

This situation happens routinely in deals especially with first time founders - when the VC likes the business but is not so sure about the capability of the founder to deliver. It’s all about negotiating power which is dependent on if the founders has other optipns. If a founder has other options, I would tend to go with less controls even with lower valuation. Worse case, one could negotiate time bound controls or event bound controls. For example, the cheque signing limit will go up after 2 years or will come down if the revenue achieved is less than a certain number. .

Your biggest leverage in negotiations is optionality. Make sure to start the fundraising process early enough. This will give you better chances of running a competitive process and avoid negotiating at the cliff of bankruptcy. In my view, control questions are best mitigated through syndication (more than one investor), independent board members, and appropriately defining decision thresholds. Introducing exotic deal structures has to be approached with caution as e.g., liquidation preferences will stack up, and the structure might hamper your ability to raise a subsequent round.

Identify critical decisions that should remain under the control of the founding team. Negotiate to retain decision-making powers on matters crucial to the company’s strategic direction, product development

Its not rocket science. Don't be afraid to give warrants, preferential rights etc to your investors. Remember, making other people successful is the best way to achieve success for you and the company. However, understand investment technicals are vital.

A term sheet is your roadmap through the intricacies of VC investment. Key elements like valuation, board composition, liquidation preference, and anti-dilution demand thorough comprehension. Valuation directly impacts your ownership stake, with higher valuations favoring you. Board composition shapes governance, impacting strategic decisions. Liquidation preference determines payout order in exit scenarios. Anti-dilution safeguards VC interests amid future financing rounds. Delve into these terms, understanding their implications on control and value. Additionally, research industry standards and analogous deals, bolstering your negotiation stance with informed insights.

Founders need to thoroughly understand control terms vs economic terms in a term sheet. I recommend to the startup founders I advise to read, re-read, and fully digest the book Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalists. The book breaks down the most important terms to negotiate vs terms that are standard and their implications on your eventual wealth creation.

One thing I have found helpful is to also ensure you guide your advisors (attorneys/financial advisors) to also prioritize your key deal outcomes. It is possible to get sucked in to negotiation tussle between attorneys especially on terms that do not matter much from either economic or control perspective. Thus, you want to ensure that you set clear priorities for your attorneys and advisors to focus on those key terms or issues that enhance your position (from an economic or control perspective) and not get hung up on seemingly important but irrelevant terms.

Communication and prioritization of your goals is important even before you receive the term sheet. It is ok to be upfront that certain terms are a non-starter. If you know this VC only invests with a board seat and pref even though they will not lead the round then it might not be the best fit.

In VC term sheet negotiations, strategic prioritization is key. Clearly define your must-haves, nice-to-haves, and deal-breakers to navigate the complexities effectively. Willingness to compromise on valuation for a balanced board or flexibility on liquidation preference within fair limits showcases a pragmatic approach. Anticipate the VC's priorities, aligning your arguments and counteroffers accordingly. This strategic alignment enhances the likelihood of reaching a mutually beneficial agreement, fostering a win-win outcome.

The best VCs are the ones who are your strategic partners and commercial heroes. They help you grow directly - this means your goals are theirs, even the small ones. Make sure to create OKRs, and clear comms between you and the investor.

As a lawyer, I might be a little biased, but I believe it's crucial to have someone knowledgeable in VC terms standards on your side during negotiations. Without this expertise, it's tough to understand the market and know when to negotiate hard or step back. Industry standards are constantly shifting with market trends, and in a buyer-friendly market, it's harder to negotiate with VCs. However, it's definitely doable.

They say seeing is believing and the best ways to "see" often comes down to modeling out the impacts of specific terms in a financial model or software application. In the heat of a term sheet negotiation, I recommend a founder either rely on a quantitatively-driven friend, an ally VC analyst/associate, or a startup advisor to model out the impacts to dilution and impacts of exit outcome based on key negotiation items in the term sheet. These are the moments when a key term (e.g., 1x versus 3x liquidation preference) become visibly apparent.

The advice I give to founders who go through accelerator programs is to ask the accelerator. A large accelerator will see more offers in a week than the typical lawyer in the average month. Accelerators have grad teams that can provide an overview of the market and quickly point out unfavorable terms. As a founder, never be afraid to walk away. A VC who really wants you doesn't accept a no and will chase you down, changing terms along the way.

As a founder your role is vision, culture and fundraising. You should have your finger on the pulse of the VC market - one of the ways to do that is through your strategic advisors (attorneys, COPAs etc.) They will help you understand landscape but also help you understand what truly the VC is looking for or angling for in the term sheet.

Understand the shift over the past few years 2020-2023. Capital was cheap/free and now it is very expensive. Valuations were extremely bloated and now in many stages down 60%. The world of outside capital has changed and so needs to be your expectations. The founder journey and value for what they are building may not match the current funding economics. Be prepared to feel pain or discomfort in the valuation - it may be the reason they are seeking "control." It is the only way they can provide that level of capital is to in kind take that much off the cap table.

Keep in mind the different fund models that VCs use in order to understand their preferred ownership. Some funds are conviction based, investing large parts of the fund into a limited number of companies, others are diversification driven, investing smalls sums into many companies. Both models have their pros and cons, but understanding what kind of VC you are getting on board can also help understand why they are asking for more (or less) ownership. Conviction driven VCs usually can bring more value because they have less companies to divide their attention between.

Check out the National Venture Capital Association's model term sheet available on the web. It's an industry standard and widely used by professionals in the field. Familiarizing yourself with it is crucial to understand the common terms and standards in the venture capital industry.

Personally, I would not work with a VC that is not proposing terms that are within market entering a negotiation. With that said, founders should make sure they understand market terms through consulting industry data sources (e.g. Pitchbook/Carta) and having a good legal counsel that specializes in VC finacings.