Negotiating with an Investor: Keys for Startups

When negotiating with an investor, an entrepreneur or startup founder must take into account several important keys to ensure a successful and mutually beneficial negotiation. Below are aspects that should not be ignored and what not to forget to negotiate:

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1.- Keys to Negotiate with an Investor:

1.1 Preliminary Investigation:

Before starting the negotiation, it is crucial to research the investor and his or her track record to understand the investor’s interests and portfolio. In other words, it must be clear to you what risks the investor is willing to take and what skills he expects from the founder.

• Risks assumed by an investor in a start-up:

  • Non-viable business model: One of the biggest risks is that the company lacks a solid business model that generates sufficient revenue to cover costs, which can lead to lack of profitability and depletion of resources.
  • Limited scalability: There is a risk that the startup may not be able to scale its business, which may affect its long-term growth and sustainability.
  • Possibility of Fraud: Investors also face the risk of fraud by startups, which can result in significant losses if the company is not transparent or ethical in its operations.

• Skills that an investor looks for in a startup founder and manager:

  • Founder’s background: Investors pay primary attention to the background and experience of the founders, as this can influence confidence in the project and the ability to execute.

• • Confidence in the project: It is crucial that the founder demonstrates confidence and commitment to his project, as this influences the investor’s perception of the viability and potential success of the startup. How does the investor gain confidence in the project?

For an investor to have confidence in a project, especially when the investment lacks significant turnover, it is essential that the entrepreneur demonstrates a series of key aspects that generate confidence in the start-up’s potential. Below are some strategies to achieve this confidence:

1. 1. 1. Personal investment: Investors tend to appreciate it when entrepreneurs invest their own capital in the project, which demonstrates commitment and confidence in the idea.
      2. Execution over Ideas: It is crucial to focus on project execution, demonstrating concrete actions and tangible results rather than just staying at the idea stage.
      3. Transparency and Trust: Maintaining transparent communication about the project, its progress and challenges helps to build a strong relationship based on mutual trust.
      4. Competent team: A strong and competent team is essential to transmit security and professionalism to investors.
      5. Detailed Business Plan: Present a detailed and realistic business plan, highlighting the market opportunity, growth strategies and expected results.
      6. Realistic valuation: It is essential to establish a realistic valuation of the business, avoiding inflating the numbers so as not to lose credibility with investors.
      7. Clear Executive Summary: An effective executive summary that highlights the business, the team and the value proposition can capture the attention of investors from the outset.

• • Transparency and Execution: Investors value transparency, ability to execute and a focus on tangible results from the founding team, which are key to building a strong relationship.

1.2 Definition of the Partner Profile:

It is important for the entrepreneur to clearly define what type of partner he/she is looking for, whether it is one that brings knowledge, capital or both, in order to align expectations from the outset.

Differences between Financial Partners, Industrial Partners, Business Angels and Family Office when Investing in a Startup:

Financial Partners:

Characteristics: They provide financial capital in exchange for a stake in the company.

Focus: Your main interest lies in obtaining an economic return on your investment.

Role: They are usually passive investors who do not actively participate in the day-to-day management of the startup.

Industrial Partners:

Characteristics: They bring knowledge, experience and contacts in a specific sector.

Focus: They seek to enhance the growth of the company through their expertise in the industrial sector.

Role: They actively participate in strategic decision making and provide value beyond financial capital.

Business Angels:

Characteristics: Individual investors who provide equity capital to emerging start-ups.

Focus: In addition to money, they offer advice, contacts and business experience.

Role: They are usually actively involved in the business, providing strategic guidance and support to the entrepreneur.

Family Office:

Characteristics: Entities that manage the wealth of wealthy families and invest in various asset classes, including start-ups.

Focus: They seek to diversify their investment portfolio and achieve long-term financial returns.

Role: They can act as institutional investors, providing capital and financial backing to the startup.

1.3 Strategic Legal and Financial Analysis:

Conducting a strategic legal, financial and tax analysis prior to seeking investors can make the startup more attractive and prepared for negotiation.

1.4 Transparency and Clear Objectives:

It is essential to be transparent about the company’s objectives and what is expected from the investor, thus building an optimal business relationship.

1.5 Data Room Prepared:

Before partnering with an investor, it is advisable to have all the commercial, technical and financial information of the startup ready in a data room to facilitate the process.

1.6 Legal and Financial Strategy:

Conduct a strategic legal, financial and tax analysis prior to seeking investors in order to be more attractive and prepared. What does an investor ask for?

2.- Aspects to be negotiated:

2.1 Control of the Company:

Do not forget to negotiate clauses that ensure that you retain control of the company and avoid situations where the investor can drain the company of its founders.

2.2 Shareholding:

It is important to agree on the shareholding of the investor and the founders, as well as the conditions for future financing rounds.

Key Data for Agreeing Equity Participation and Financing Conditions:

• Startup valuation:

Determines the current value of the company, which will impact the shareholding to be granted to the investor.

• Investment Amount:

Specifies the amount of capital the investor will contribute to the startup, which directly influences the equity stake.

• Pool ESOP (Employee Stock Ownership Plan):

Some investors may require employee participation programmes to be set up as part of the deal, which implies the possibility of allocating shares/equities of the company to the beneficiaries.

• Settlement Preferences:

Defines the order of priority in the distribution of assets in the event of liquidation, such as a sale or acquisition.

• Voting Rights:

They detail the decision-making power that investors will have in the startup’s operations, which affects the strategic direction and control of the business.

• Representation on the Council:

Some investors can obtain a seat on the board of directors, which impacts the decision-making and future direction of the company.

• Anti-dilution clauses:

They protect investors against possible future dilution of their shareholding in subsequent rounds of financing.

• Reverse Vesting:

Specifies maturity plans for founders and key team members, which is common among startup founders.

3.- Realistic Assessment:

The valuation of the business must be realistic to avoid inflating the numbers, which may affect credibility with the investor.

In order to make a realistic investment based on a pre-money valuation of a startup, it is essential to understand some key concepts and consider certain aspects. The pre-money valuation is the value assigned to the company before receiving any additional investment, and is crucial when negotiating with investors, as it defines how much of the company you are willing to give up in exchange for the investment.

Steps to Realistic Investment:

•  Understanding Pre-Money Valuation:

This is the financial value attributed to the start-up before receiving new investment. It defines the basis for calculating the investors’ equity stake after the investment.

• Importance of Pre-money valuation:

It is essential in negotiations with investors and can strengthen your position during financing discussions. Define how much of your business you are willing to give up in exchange for investment.

• Calculation of the Pre-money Valuation:

It is determined by considering factors such as growth potential, market position, equipment, intellectual property, among others. The post-money valuation is calculated by adding the investment obtained to the pre-money valuation.

• Strategies for Assessing Valuation:

Venture Capital Method: First calculate the post-money valuation considering the final value of the startup and the ROI, then obtain the pre-money valuation by subtracting the investment received. Consider possible future dilutions when calculating the percentage of equity you could divest.

4.- Executive Summary and Business Plan:

Submit a clear executive summary highlighting the business, the team and the market opportunity, together with a detailed business plan.

Conclusion:

In the business world, negotiating investment contracts and terms is a critical step that can determine the future success of a start-up. Having specialised legal advice is fundamental to ensure fair and solid agreements that protect the interests of founders and investors. In this regard, ILP Abogados is a strategic ally that provides experience and legal expertise to guide entrepreneurs in this crucial process.

To secure fair and beneficial agreements in negotiating investment contracts and terms, trust ILP Abogados. We have advised on 94 transactions in the last two years. Our team of business law experts is ready to advise you and provide you with the legal support you need to protect your interests and secure solid agreements. Don’t leave the future of your startup to chance, contact ILP Abogados today to get the legal advice you need!

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