10 essential tips for not burning your negotiations with investors
By: Ben Topor, Partner at Cukierman & Co. Investment House. Green Technology
Getting to yes is a process with plenty of potential pitfalls. Here are some hard earned lessons from the pros
Israeli entrepreneurs have made a name for themselves in the high-tech world thanks to their courage and initiative. Unfortunately, sometimes it is precisely because of these qualities that they may lose leverage in the negotiations with investors.
I recently met with entrepreneurs who showed me a sales forecast of $300 million for the following three years. Only later in the discussion did they decide to clarify a marginal fact: they have no income at all to date, but merely a strong working relationship with potential customers. Because their chances to meet this forecast are slim to none, the good impression they had hoped to make through their forecast was damaged, as well as their credibility, in my opinion.
These entrepreneurs are not alone. Many companies which are currently raising capital present investors with great forecasts that show very high potential growth, thinking that investors will be impressed and excited, wanting to respond positively and invest their money quickly before the opportunity is gone.
In reality, the recruitment process can take more than a few months. Meanwhile, the investors have plenty of time to test the real performance of the company, by looking at the way the company had been presented to them in the beginning of the negotiations and comparing it to what the company will actually be at the end. When the company’s forecast is far from the expected level of income, there are then implications on the value of the company and the feelings that investors have about the reliability of the company. At the end of the process, the ones who get hurt are the entrepreneurs themselves.
This is just one example of a number of common mistakes that are made by Israeli companies on their way to recruit. Most of them have no real ability, time, experience nor international contacts to conduct a genuine process that will lead them to a faster deal, and certainly not a deal that maximizes their potential.
So how can you do it correctly? Here are ten tips for proper fundraising.
1. Build a successful story
When selling or raising capital for a company, the question “why” always rises. Buyers will wonder why the entrepreneurs / owners of the company are selling the company if it is so successful, especially if the company is planning to generate a lot of profit for the shareholders.
2. Realistic Forecasts
A forecast that is exaggerated, as mentioned before, is harmful to the company. The credibility of you and your company is worth money. It is not recommended to show a growth that is too high and blown out of proportion only to impress, but rather try to present the most realistic forecast as possible.
If reality still does not match the forecast as the process moves forward, it is recommended to immediately inform the potential investors about the situation.
If you are in the midst of a negotiation process, it is better to proactively inform the investors of a mistake rather than having them discover it by themselves and thus leaving them with a negative impression. In some cases, it is even better to present a forecast that is slightly less optimistic at first and surprise them with good news later. If you currently have no income at all, do not present long-term forecasts. It is also important to have a clear methodology showing how the forecast was built, what are the chances of implementation both on the income level and particularly on the costs level.
3. All preparations need to be done before negotiations
Many investors are disappointed if the required information and presentations of the company are not done professionally or if the company did not properly prepare prior to entering negotiations (i.e. by presenting a financial model, valuations, performances, projections, etc.). If the material was prepared specially for a particular investor it could imply that the company is not attractive because they seemingly have no other possible investors interested in them. Prepare a Data Room for the investors to be able to enter and review the materials.
4. Find investors who are most relevant to you
Sometimes contacting an investor when the company is still too immature may be risky and burn future bridges as it may not meet the investor’s criteria. Usually, investment meetings have in-depth discussions and if there is not enough information or evidence for growth, this can harm the company. There is typically only one chance to make a positive impression (about the growth of a company), after which it becomes much more difficult. If for example, you are trying to sell a company to a larger company from the same sector, it is important to present them with the synergies in expected levels of income and outcome in the acquisition. This gives you the opportunity to increase the level of attractiveness of the deal by treating it as a way to decrease the expenses of the company and increase sales.
5. Money is not everything
An Israeli company needs to know how to maximize the process of selling or recruiting funds, not just regarding money but also regarding conditions such as: the amount needed to be raised, the company’s value and percentage of ownership, the types of shares and given sales conditions, the presence of one of the board of directors of the company during negotiations and other conditions that may be important to the company.
The last investment round of the Israeli company TRAX (who developed image-processing services for the retail market and other producers) was led by us. We invited a number of international groups to look into the company for possible investment. Through the process of correct negotiations, the company could afford to move forward with the best offer, both in terms of price and other required conditions that were previously mentioned.
6. Negotiate with different investors at the same time and make sure that the investors are aware of it
An Israeli company does not need to sell itself for cheap, but to maximize the price as much as possible.
When a large entity is keen on buying out or investing in a company, but understands that the company has no other investment options and therefore no competition, it has a large advantage in negotiations.
There is no need to be too direct and tell an investor that he has competition (which may come off as sounding arrogant), but rather make sure that it is known through the grapevine, indirect factors or general statements, that there are other negotiations with different investors taking place. If the investor understands that other investors are interested in the company, then he will be inclined to make quicker decisions.
7. Don’t put everything you’ve got in one basket
Parallel negotiations can be useful even in cases where there are advanced negotiations with an investor or big buyer. Advanced talks often end in last minute disappointments, causing damage to the motivation of the company and to its management. You should save your energy and resources and not put everything you’ve got in one basket. Be aware that advanced negotiations are not a guarantee for safe investments or exits.
8. Get help from a third party
Sometimes there is no agreement between the shareholders within a company regarding its future, so that it is highly recommended to use a professional consultant who is objective and is not dependent on the process. This person can recommend the correct, professional way for the company to proceed. This makes it easier to achieve consensus and to access the most strategic level of selling and fundraising.
Investors who feel that the negotiations are managed by someone who is experienced, serious and represents a unified group of opinions and goals, will be prompted to act quickly and invest in the opportunity.
9. Valuation of the company
I usually encourage entrepreneurs to raise capital by valuations that are relatively high (in order to minimize the dilution of entrepreneurs) but, if the valuation has no connection to the financial results of the company, each round of future fundraising will be extremely difficult.
Making fundraising rounds while the value of the company is decreasing (what is referred to as “down rounds”) are very difficult psychologically, both for existing investors who will argue against them, and for new investors who might get the impression that the company is failing and would rather give up the deal.
10. Don’t share all of the information right at the start
The entrepreneurs can understand if the investor is engaged if he requests further materials. Try not to provide detailed financial information and pipeline too early.