Negotiating a funding round

Negotiating a funding round is difficult and you can easily lose the entire thing if you don’t know what you are doing. Rumor has it that you should get a good lawyer to help you. But truth is, no lawyer can do the negotiation part for you.

So let’s get the basics.

Who is negotiating?

The funding round is negotiated from two distinct hats. On one side, the company that raises funds is requesting financing via equity financing. On the other side, the shareholders of the company are negotiating the financial return and the rights of their investment position with new investors.

Those are two very different shoes.

As a company:

  1. You need a business plan and all that strategic material that answers the S&U questions, or the question on sources and uses of funds available.
  2. You need to show the financial position and projections/forecasts, the opex expansion and capital allocation plan, and all that.
  3. You also need to answer towards key risks that companies in your stage typically have. Those do not include spending money. But hiring good talent, meeting execution plans around operations, development, marketing initiatives. And possibly getting customer feedback and customers.

You sell a result or possible value after the funds you raise have been consumed over k months. Your business plan and strategy tell the investor how plausible it is to get to this result and how to plan to allocate the funds. He buys in or not.

With this in mind, you fix the amount of capital raised and the milestones the company has to meet – especially if investments are tranched. Most of the titleguarantees and reporting requirements in the investment agreements are directed to the management and they give investors a way to remedy. This should of course include you as a shareholder in your company. The rights to remedy should not only protect new shareholders, but all shareholders. If they are deemed generally valid and relevant for shareholders.

What you do not do as a managing director or as a representative of your company is:

  1. Care who owns your company. As a managing director yes. As the company, no.
  2. Care about dilution of your shareholders – or you. This is strictly something that the shareholders have to care about

As a shareholder:

  1. You ultimately want to lose little shares in your holdings of the company. So you are interested in a high valution.
  2. As a shareholder, you want to lose the least amount of control over your investment and hence when negotiating rights associated to e.g. the Series Seed shares or the preferred share class issued, you are negotiating as shareholder. It is simply none of your business as management director what the shareholders negotiate and do. Even if you are two persons in one most likely.
  3. You want to ensure that all rights and entitlements associated with new share classes that protect shareholder value should also protect you as e.g. a common shares holder.
  4. You also have an interest to prevent other shareholders from using particular performance successes or failures to benefit a single or a set of shareholders over others. A missed milestone by the company should equally


How to start a negotiation

Step 1: Flooring the valuation discussion
You start a negotiating with two hats and two single statements.

  1. The Company needs € x in cash to execute on the businss plan for next y months.
  2. The Shareholders are willing to accept equity financing of this amount as a valuation of z.

And you should absolutely nail a range with just these two or three dimensions:
1. Money raised.
2. % you give away for this
3. Time in which these funds will be consumed.

If you are negotiating on this level and get a commitment of let’s say €500k investment for 10% in the company, you have effectively created the following term sheet.

  1. You raise €500k
  2. You give out 10% of your common shares.

Step 2: Pumping the valuation

Especially 2 is very important. Because from this starting point, you can price up the valuation for every right that the new shareholder wants.

  1. Preferred share class ? Valuation goes up.
  2. Liquidation preference ? Valuation goes up.
  3. Tranched Investment ? Valuation goes up.
  4. Milestones ? Valuation goes up.
  5. Put Option ? Valuation goes up.

As you are using this framework to pump up the valuation, you will (a) learn the price points that this investor gives for each right, and (b) slowly leave the range at which the other investor is willing to invest. That is a good thing.

For example a put option is posing a massive risk to the shareholders and the company and should be rigidly priced. If you do a proper risk adjusted valuation of this, you might go as far as 18% valuation increase.

Step 3: Entering the shareholder negotiation

Now you have pumped the valuation too high. How do you get it down?

  1. By dropping requests and terms that the investor would like to have.
  2. By doing counter-requests

What kind of counter requests are there?

  1. Investor pays (at least in part) legal fees of the transaction.
  2. ESOP pool is not only coming from last financing round share class, but also is granted from current share class (the option pool shuffle) and are granted to founders under a benevolent vesting agreement as managing directors of the company (not shareholders!), protected from being fired and kicked by some solid good leaver bad leaver clauses.
  3. Voting and Decision rights remain with common or with all shareholders, not only new share holders
  4. Board Seat position for trusted / friendly advisor
  5. Investor has milestones, too : e.g. supporting in key hiring, generating k leads, etc.
  6. Call option for Common Shareholders to call back preferred classes if conditions are met, e.g. delayed tranched payments, non meeting of milestones.

The Company Negotiation


Don’t negotiate without competition

The above negotiation framework only works if you either don’t need equity financing or your have a serious line up of interested investors negotiating with you.

If you need money and talk to only one potential investor, forget negotiation and accept you will be screwed. There is imply no way you can push for anything.

The only way to win a hostage negotiation is to fully play against the risk of the counter party. Once people are invested in your company, you can always negotiate by threatening to leave the company. But that is not something you can do as first time founder and someone that isn’t yet established.



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