Lesson #1: How are you going to negotiate with an Investor?
This article shows how an inexperienced entrepreneur should deal with angel investor questioning.
There are simply not enough articles and resources on the internet on how an entrepreneur should negotiate with a potential business angel investor and the types of questions that will be asked in your first meeting.
This article explore some of the questions that should be considered as well as the due diligence that should be done prior to an angel investor meeting.
We are a former entrepreneur and angel investor network that featured thousands of investment proposals to high calibre angel investors, including investors from the UK Sunday Times Rich-list. From our unique position witnessing both sides of the funding equation, we found that entrepreneurs who negotiate properly:
- Receive better terms – in terms of % equity they will continue to own in your company vs the investment capital you raise.
- They will not lose a potential deal because they have failed to value what a business angel investor can actually bring to their company (know-how, experience, network of contacts), and…
- They will be able to walk away from the deal (if need be) as getting the right answers to the right questions from an investor will empower them to walk away if the proposed deal is not a good fit. It is important to remain impartial during negotiations and ask the kinds of questions that will uncover red-flags.
So when you have a full business plan with financials and a thorough knowledge of your industry, now what?
Fact #1: Your Investment Summary is NOT your Executive Summary
Angel investors are highly successful business people, which is why they are able to afford high risk non-traditional investment propositions (YOU!). They will get approached daily by pie-in-the-sky entrepreneurs and time wasters that just want to talk about their ideas without the requisite legwork. So when you are invited to deliver your investment pitch to an angel investor, it will be important to stand out from the crowd by knowing your business plan inside out (including the financial section). We recommend having a great presentation that may include PowerPoint slides with graphics demonstrating your key points of your investment pitch and a well-written one page ‘investment summary’ (which is NOT your executive summary). The latter should be tailored for the angel investor you are meeting. Ready to be handed out straight after your initial pitch or preferably, handed out after the Q&A session when your meeting has ended which will act as a refresher.
The decision to invest will never be made during your initial pitch BUT the decision NOT to invest could be. It is vital that you are articulate and speak in a language that a potential investor finds reassuring. Knowing your business plan inside out will also help with credibility.
Handing out a fully bounded business plan after your investment pitch, when an investor has not asked for a copy, will likely end up unread. A half page or one page investment summary on the other hand will formalise and add credibility to your investment pitch. It will also increase the chances of an investor perusing the key points of your pitch at their own leisure. If you would like to find out how to write the perfect investment summary or would like to know the difference between an executive summary and an investment summary please follow this link.
Fact #2: Angel Investment does NOT happen overnight
Receiving investor interest and pitching to them successfully is hoop #1. The process of actually signing contracts and receiving angel investment will most probably be hoop #4 or #5 and can take many months to complete. Experienced angel investors will not draft contracts and send funds over without first seeking out their own legal advice. So remaining patient, strategic and prepared during this time is crucial.
Fact #3: Angel Investment is not just about Money
Angel investment is a value proposition for both sides and the past experience and success of the potential investor should be recognised and valued correctly by an entrepreneur.
Recognising the non-monetary value that an investor can bring to your business is an important consideration. For example, receiving an angel investment from one of the founders of Skype and their expertise in guiding your start-up. It would be fair to say that the value in guidance in this case could end up being more valuable than the investment capital itself. In such a scenario, you would be more receptive to receiving less investment for more equity. Valuing an angel investor’s possible future contribution to your business will rely on your own due diligence and we will address this issue further in the Q&A section below.
Questions to ask Investors during negotiations
It is good practice to ask a potential investor to sign a Non-Disclosure Agreement (or NDA) before revealing any sensitive facts about your business. An NDA can do no real harm to both parties.
There is a modern school of thought that debates whether or not an NDA is a legally enforceable agreement. Regardless, when an entrepreneur insists that a potential investor sign the agreement, it sends out some very clear positive signals, namely:
- That you are serious about your idea or business.
- That you have made it clear, and in writing, that you are now entering talks in areas that you feel are confidential and that you (in no uncertain terms) do not want the information that is discussed from this point forward (or documents that you subsequently disclose) passed on without your express written permission.
- And, in the case that a potential investor simply states that they do not wish to sign the NDA (for whatever reason) then this will be a clear indication that you should be on-guard and perhaps less co-operative with the quantity of information you provide. The usual reason for an angel investor refusing to sign an NDA is that they are already working in areas that conflict with your business. That would be your first red flag that should seriously think twice on the information that you are willing to disclose.
Once the ‘Non-Disclosure Agreement’ is signed (or not signed), this will be a good time to value the contribution that the investor could make to your company by considering:
- Has the Investor worked in your industry sector and if so what is his/her experience level within it?
- What resources does the business angel investor already employ that you may be able to leverage? Example: access to office property, access to experienced sales staff, existing know-how in your industry, trade suppliers, existing distribution networks to wholesalers and suppliers that your product could piggy back off? Is there some way to leverage this as part of the angel investment package (example, one or two years of free rent on office space)?
- What companies has the investor invested in to date? What companies does the investor privately own? It is worth carrying out credit checks on these public companies at a later date, to provide you with valuable insight on how this investor manages his/her own businesses.
- From the investor’s past angel investments, how many of them are similar to your business and industry sector? How well are they doing? Also how many previous business angel investment successes has this investor had?
- From point 4 above, if the investor has had past successes in his angel investments, ask what qualities the entrepreneur had that first attracted the investor to invest in him/her. This can provide you with a candid view on the types of qualities the investor will be looking for in you.
- Has the angel investor exited from any of his/her past business investments? If so, what were the results and how much of it was as a direct result of the investor? Would the investor be comfortable with you contacting the entrepreneur(s) involved in that business? If not, why not?
- If you do retrieve the entrepreneur’s contact details from point 6 above, call him/her and ask what level of support the entrepreneur received during their time together? Contacting an entrepreneur that has exited and is no longer involved with the investor will yield far more honest and upfront commentary over someone that is still currently involved.
- How many business investments (NOT traditional investments such as stocks, bonds, property investments etc.) has the investor made in the past? This is a revealing question as most experienced business investors will know exactly what they want from you and your business from day 1. Less experienced business investors will be far more hot/cold during meetings and may tend to make commitments verbally that are later broken when they have consulted their own network of friends and advisers. This does not happen all of the time, but more often than not, a less experienced investor may seem friendly and agree to a whole host of terms verbally in a meeting and at the last minute change all of the terms. Expectation management is key.
- Always be on the look-out for the ‘good cop, bad cop’ routine played by an investor and his adviser. Most important of all, if negotiations are later fully delegated to an investor’s adviser, it is best where possible (funds allowing) to have your people talk to his/her people. It can be quite an exhausting experience trying to negotiate terms with an adviser who does not have the final say on key decisions. Even if the investor states that the adviser has full power to negotiate on his/her behalf, ultimately the final decision resides with the investor.
- What payback period is the business angel investor realistically looking at for his/her investment in you? What is the investor’s expected timescales for an exit in his investment? Is the investor looking for a short term, medium term or longer term return on his/her investment?
- Is the investor willing to be on the board of directors of your company? This can indicate the amount of involvement that the investor is willing to provide over their angel investment.
- Will a lawyer/solicitor be drafting the legal documents for the angel investment and deal structure in your company? If so, will you retain your own counsel whilst these documents are drafted? Also, it is not unheard of for an angel investor to take the stance of not using corporate lawyers to draft agreements. If an investor chose to invest in 8 – 10 companies, the total legal bill could turn out to be well over £50,000. Whatever the situation for the investor, an entrepreneur should always pay for legal advice before signing any contract so that all terms are fully understood and you enter into any agreements with your eyes wide open.
- In terms of deal structure, if an investor is purchasing equity, what type of shares will they purchase (common shares or preferred shares). Have you spoken with your accountant or tax adviser in terms of the potential tax benefits and downfalls to the different types of structures an investor may propose? Always do check if there are any warrants or share options attached. Or, would the investor instead wish to assume responsibility for some kind of debt in your company? If so, ask your lawyer to check whether the debt will be classed as subordinate debt or convertible debt.
- And finally, Net Worth of the investor – though you may never know what the exact net worth of your potential investor is, it is important to understand that an investor should have at least 7 – 10 times more in liquidity over the amount that they are going to be investing in you. So if you are seeking £50,000, the angel investor should have around £500,000 of liquid assets (shares, positions in gold, cash etc.) over the short term, whilst being able to service their own debts.
Net worth is important because an investor that you choose to partner with must always provide strength to your business relationship. This strength cannot come from someone who is constant fear of losing their investment if the venture fails or does not make money in the first quarter. This is not a question of wealth but affordability and as a result, it is important due diligence is carried out beforehand to ensure that the investor is financially robust.
The points above are not exhaustive, but should set out a good foundation to the types of questions you should consider asking during negotiations.
Entrepreneurs must always remember that even though it appears difficult to raise angel investment now, they owe it to their ‘future-selves’ to ask as many questions as they can today.
UPDATE TO ARTICLE: We have received emails from entrepreneurs that are looking for a list of questions that angel investors will ask. A good list of questions can be seen here: Angel Investor Due Diligence. Ensure that you have answers to these questions before meeting an investor. Again, the above link is not exhaustive, but it is a good starting point.