Negotiations with investors: how to not destroy a deal
By: Ben Topor, Partner at Cukierman & Co. Investment House. Green Technology
Israeli entrepreneurs have made a name for themselves in the high-tech world thanks to their courage and initiative, however, precisely because of these qualities, they may lose quite a bit in their negotiations with investors.
I recently met with entrepreneurs who showed me a sales forecast of $300 million for 3 years. A bit later they decided to specify a marginal fact: to date they have no income at all, 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 achieve 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 growth, thinking that investors would be impressed, excited, respond positively and invest their money quickly before the opportunity will be missed.
In practice, the recruiting process can take more than a few months. Meanwhile, the investors have time to test the real performance of the company, through looking at the way the company was presented in the beginning of the negotiations and what the company actually is at the end. When the company’s forecast is far from the level of income, there are then implications on the value of the company and the feelings the investors have on 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 or experience and international contacts to conduct a genuine process that will lead them into a faster constant deal, and certainly not a deal that maximizes their potential.
So how can you do it in the right way? Here are 9 tips for proper fundraising:
- 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 it is going to be collected in profits of the shareholders.
- Realistic forecasts
A forecast that is over 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, however try to present the most realistic outlook as you possibly can.
If the reality still does not match the forecast as the process moves forward, it is recommended to immediately inform the potential investors.
If you are in the process of negotiations, it is better to inform them in a proactive manner rather than having them reveal it by themselves and leaving them with a bad feeling. In some cases, it is even better to have a forecast that is slightly less optimistic and surprise them later with good news. If you have no income at all, do not show long-term forecasts. It is also important to have a clear methodology on the basis of how the forecast was built, what are the chances of implementation both in the level of income and particularly in the level of costs.
- All preparations need to be done before negotiations
Many investors are disappointed if the demanded information and presentations of the company are not done in a professional way and if they did not prepare prior to entering negotiations (financial model, valuation, performance, projections and other). If the material was prepared specially for that investor it could imply that the company is not attractive especially because they are the only ones interested in investing. Prepare a Data Room for the investors to be able to enter and review the materials.
- Find investors who are most relevant to you
Sometimes contacting the investor when the company is still immature and does not meet the criteria of the investor can “burn him for the future.” Usually the meetings have in-depth discussions and if there is not enough evidence for growth, the company can get hurt – there is only chance to make an impression of a leading and growing company, after that it becomes more difficult. If, for example, you sell a company to a larger company from the same sector, it is important to present to them the synergies in expected level of incomes and outcomes 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 the sales.
- Money is not everything
An Israeli company needs to know to maximize the process of selling or recruiting funds, not just regarding money but conditions such as: 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 and other conditions that are important for the company. The last investment round of TRAX (developed image processing services to the retail market and producers) was lead by us. We brought tens of international groups to look into the company. Through correct negotiations the company chose to go with the best offer, both in terms of price and other conditions that were previously mentioned.
- Negotiate with other investors in parallel, and make sure that the investors know they have competition
An Israeli company does not need to sell itself for cheap, but to maximize the price as much as possible. When a large entity wants to buy out or invest in a company, and understand that the company has no other options, it has a large advantage in negotiations.
There is no need to say to the investor directly that he has competition and sound arrogant, and definitely not go into the small details, however make sure that it is known through indirect factors or general statements that there are other negotiations with different investors happening. If the investor understands that other investors are interested in the company he will be inclined to make quicker decisions.
- 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 the motivation in the management of the company. You should keep your energy and resources and not put everything you’ve got in one basket, and be aware that advanced negotiations are not a guarantee of safe investments or exits.
- Get help from a 3rd party
Sometimes there is no agreement between the shareholders of the company, so it is highly recommended to use a professional consultant that is not dependant and will recommend the right way for the company to proceed. This makes it easier to get consensus and access to the most strategic process of selling and fundraising. If the investor feels that the negotiations are managed by someone who is experienced and serious, he will realize that this is not just another deal being made, and he may be left out if he doesn’t act quickly.
9. Valuation of the company
Of course, I encourage entrepreneurs to raise capital by valuations that are relatively high (in order to minimize the dilution of the entrepreneurs) but if the valuation has no connection to the financial results of the company, each round of future fundraising of the company will be extremely difficult. Making fundraising rounds while the value of the company is decreasing (“down rounds”) are very difficult psychologically, for existing investors that will argue against them and also for new investors who might get the impression that the company is failing and would rather give up the deal.