Negotiating and Closing Your Series A Funding Round

The entire process of raising a Series A round of financing for your startup usually takes several months.

It starts with self-evaluation to determine whether your company is ready to raise a new round of funding. If you’re good to go, you begin the process of trying to identify the right venture capital firms to target, networking and meeting potential investors, and preparing your pitch for when the time comes to sell your vision to them.

Even when you’ve found an investor who wants to work with you, you’re still not done. Not even close. While mutual interest might exist, there’s still a lot to be discussed and evaluated.

Most notably, you still need to negotiate, finalize, and close the funding deal before you can start popping champagne bottles.

The process of negotiating and closing Series A funding rounds can be fairly complex and stressful. But that shouldn’t be anything new to founders when they reach this stage; practically every phase of the fundraising process thus far has probably had its share of complexity and stress.

This is yet another phase of the process in which we highly recommend founders seek the guidance of their trusted and most experienced advisors, especially investors.

No one is going to be able to negotiate the deal for you, but there’s nothing wrong with getting some outside advice from experiences mentors as the process unfolds. Remember, you’re dealing with venture capitalists; negotiating deals is what they do for a living.

So, while you certainly can’t expect to get the best of them or have the upper hand in negotiations, that doesn’t mean that you can’t still negotiate to get a deal that’s going to be beneficial for you and your startup.

Finalizing the Term Sheet

In one of our recent blog posts, we talked in detail about terms sheets. The term sheet is an agreement outlining the key terms of the investment, such as who controls what percentage of company shares and who gets what if an exit occurs.

The term sheet itself gives you a mini negotiation that you can use to imagine what the talks for closing the deal might look like later. It also provides you with a good opportunity to get to know the investors based on the terms that they prioritize.

Remember, once the term sheet is signed, an exclusivity provision usually kicks in, which means that you can’t talk to or negotiate with any other VCs for at least a month to 45 days.

Unless something goes horribly wrong during the course of the term sheet negotiations, the best course of action is usually to stay committed to the investors once a term sheet has been signed.

Technically, you could continue to shop your startup around once the exclusivity period has ended, but think about it: how can the next investor be sure that you’re not going to do the same thing to them?

The general consensus in the VC world when a deal dies post-term sheet is that the startup was the problem, not the investor.

Know What You Want

Your priority during term sheet negotiations is to focus on what you care about most. Identify the factors that you believe benefit your startup most and make a push to get your investors on the same page.

It’s important to have a plan. Know what you want to get out of the term sheet. Even if it’s normal to wait for the VC firm to reveal its terms first, ensure you have a draft of the investment terms you’d like to see ready to go.

Determine ahead of time which terms you’d be willing to compromise on and how flexible you’ll be regarding various standard aspects of the term sheet.

When negotiating the term sheet and while closing the deal later, it’s important to remember that your Series A terms set a precedent for all future rounds of funding, which is why it’s important to make sure that the terms are as favorable for your company as possible.

Ask All Your Questions

If you’re raising a Series A round and this is your first startup, then this is probably the first time you’re negotiating a term sheet. The investors on the other side of the table are probably negotiating their third term sheet of the quarter.

Don’t be afraid to stop talks at any point and ask questions if you don’t understand something. The investor understands that you aren’t as experienced in this process as they are and will be sure to oblige you.

In such a situation where the future of your company and millions of dollars are at stake, there is no such thing as a dumb question. Remember, negotiating term sheets is not what you do for a living; it’s what the investor does. Your job is to know your company inside and out, know what’s best for its future, and try to execute on that.

Negotiating Tips to Help You Close the Deal

Over the last several years, it has become abundantly clear that raising funding is the best, fastest, and most effective way to increase a startup’s chances of success. Most importantly, venture capitalists’ interest in investing in startups in hopes of hitting on a unicorn has never been greater.

According to available data, US venture capital funds raised a total of almost $70 billion in 2020, despite the shaky economic situation brought about by an ongoing global pandemic. That’s the most money ever invested by VCs, breaking a record set in 2018.

Today, more than ever, any startup that shows early success and steady growth has a decent shot at raising a big round of funding. The key is being able to take advantage of that opportunity when it presents itself.

When negotiating and closing Series A rounds, founders must strive to secure the funds they need to accelerate their startup’s growth, maintain as much equity as possible, and hopefully set themselves up for an even bigger future round of funding when the time is right.

Let’s talk about several negotiation best practices that can help founders achieve these goals when working on closing the deal.

Document the Entire Process

Documenting various agreements and stipulations that might have been confirmed via a phone call or an in-person discussion can be as simple as sending an email.

Send an email to highlight what was discussed and agreed upon during the meeting. Hopefully, you’ll get a confirmation email back. If not, at least you’ll have documented everything in writing so that you can refer to the email if disagreements arise later regarding the details that were discussed.

Focus on Alignment and Expectations

As we discussed earlier, clarity is of the utmost importance in term sheet negotiations. Be sure to ask questions that will clearly articulate the investor’s timelines and expectations.

Investors welcome questions because they confirm your interest in the partnership and help avoid misalignment during the negotiation process.

Don’t kick off the negotiations with a focus on money and equity. Talk about your partnership and what you expect your investors to bring to the table in terms of high-level cooperation.

Do you expect your investors to provide you with mentorship, help networking, and strategic advice when needed? Make sure that they are aware of these expectations right from the start.

Investors tend to prefer working with founders who are passionate about their startups and adamant about forging a strong partnership with the VC. And most experienced founders will tell you that cultivating the right partnership and culture of cooperation with investors tends to be a very crucial aspect of achieving the goals that a startup sets out to accomplish through raising capital.

Confirm Investor Interest and Intent

Being an attentive listener at the start of your negotiations can tell you a lot about what the investor truly thinks of your startup and what you can expect to see from them in terms of cooperation.

The terms investors propose when negotiations kick off can reveal much about their interests and intentions. For example, if you notice that the investor is focusing on controlling terms such as voting rights and board seats, this could mean that they aren’t overly confident in your management team and would like to assume greater control of how your company is being run.

Then again, their interest in these terms might mean the opposite and actually display their belief and optimism in regards to your leadership. You won’t know if you don’t ask.

Encourage open discussions regarding the investor’s enthusiasm for your startup’s mission and how they envision their strategic involvement to gauge their interest and intent.

Identify Your Leverage

In these negotiations, the investors tend to have most of the leverage. Your startup might demonstrate huge growth potential, but in the end, you wouldn’t be looking for funding if you didn’t need the money to achieve your business goals.

VCs are fully aware that they are needed by startups who want to improve and speed up their growth trajectory, which is why most of the leverage is on their end. However, that doesn’t mean that you don’t have any leverage of your own; you just need to identify what it is.

If your startup has been very successful and has attracted a large number of investors, that could be great leverage for maintaining equity. But the majority of startups aren’t in such an enviable situation.

Even if your startup does have more than a few suitors, if you’re not showing signs of becoming a unicorn, most VCs you pitch to will offer you very similar deals despite the fact that a solid number of different firms are showing interest.

The key is finding the right leverage for your situation. For example, say your investors are very impressed with your leadership team and your startup’s ability to attract top talent thus far. Make it clear to them that there’s a good chance that your top performers might move on and that you won’t be able to attract the same level of talent in the future if your equity is overly diluted.

An angle that gives you leverage in these types of negotiations will almost always exist; it’s just a matter of identifying it and properly using it.

Honor Your Agreements

Remember when we talked about documenting the process so that verbal agreements can’t be easily rescinded by investors? Be sure that investors are doing the same for you.

If you’ve agreed to something, whether officially, in written form, or verbally, don’t break the agreement. Reneging on an agreement will change how investors look at you and negotiate with you immediately.

Negotiations of this nature need to be built on trust. Breaking an agreement breaks trust between you and your would-be investor and it can definitely damage your reputation in VC circles very quickly.

If you knowingly made an agreement during negotiations, whether it was a good idea or not, stand by it and honor it.

Legal Documents You’ll Need to Close the Deal

Any investor who has raised capital can tell you that the number of documents you need to process seems to increase with each passing stage of the funding process.

The tail end of the process is no different. Other than the term sheet, here are a few other important documents that you and your investors are going to need to officially (and legally) close this round of funding:

• Preferred Stock Investment Agreement: Sometimes called a Stock Purchase Agreement, this document makes the relationship between the investor and startup formal and legally binding once signed. The document includes details related to representation, indemnification, closing conditions, the deal price, and more.
• Investor Suitability Questionnaire: This is a document that you need to provide to the Security Exchange Commission (SEC). It will prove to the SEC that the investor is accredited, which opens the door for the startup to file a private placement exemption with the SEC. Be sure to involve your lawyer in the process of putting this questionnaire together.
• Investors’ Rights Agreement (IRA): The IRA is an agreement between the startup and investor that includes details such as information rights, registration rights, contractual rights, and more. The investor will draft this document to feature the specific closing conditions that the VC requires.
• Amended & Restated Certificate of Incorporation: Since Series A financing almost always results in the investors receiving preferred stock in your company, this document is needed to address these changes in the company’s control and economic rights. Your shareholders will be heavily involved in this process, not just in putting it together, but because a majority shareholder approval is required to confirm the certificate.
• Written Consents: A Series A financing round is obviously a big deal, which is why you need to have documents of consent that explicitly state that your board and your shareholders approve of the funding.