Venture capital

Negotiating a venture capital investment deal


Negotiations for investment with a private equity venture capital (VC) business can last up to a year, and follow several key stages, from presenting your business plan to final negotiations and sign-off for the investment agreement.

Special advisers

Most companies seeking VC funding employ specialists to advise them on the various stages of the negotiation process. They can include:

  • accountants - who can help you draw up and review your business plan
  • legal and tax advisers - for legal planning and fiscal aspects of the deal

Six stages of a venture capital investment deal

1. Presenting your business plan
Use your first meetings to try to decide whether you would feel comfortable working with the investors long term. You should also research the fund's investment performance with similar companies, and how it operates.

After you present your business plan, the investor will decline your proposal, request more information, or ask for another meeting.

2. Initial negotiations
If they are happy with your outline proposals, the fund managers may offer you an initial memorandum. This is a programme of further negotiations, based on your business plan.

3. Company valuations
Price negotiations centre on the amount of equity you are prepared to give up in exchange for investment. The agreed price forms the basis of the fund's return on investment.

Both you and your potential investors can use analytical tools to determine values.

Common valuation tools include:

  • measuring discounted cashflows - comparing positive cashflows with risk-free investments such as a government bond, and building in a risk factor 'discount'
  • comparing your company to similar companies - eg in terms of profit, cashflow and turnover
  • opportunity cost analysis - comparing the likely profitability of your proposal with that of investments with similar risks

4. Offer letter
After agreeing a valuation, the fund will give you an offer letter, detailing its proposed investment. The document summarises the interim terms of the deal, subject to due diligence. Once you have accepted the letter, due diligence and final negotiations can take place.

5. Due diligence
Fund managers must ensure they have exercised due diligence before they invest in your company. This involves audits by lawyers and other consultants of both your company and your proposal.

6. Final negotiations
During final negotiations, the terms of the deal are agreed and signed off.

At this stage, you and your senior management team can negotiate your personal equity stake in the company, post-investment. This should take into account issues such as the company valuation and the investors' exit strategy.

Investment deal documentation

After sign-off, lawyers for the parties will draw up acquisition documents, detailing the terms of the negotiated contracts according to legal requirements. These include:

  • shareholders' agreement - the rights and obligations of each party
  • investment protocol - share prices and numbers of shares
  • changes to company statutes
  • warranty letters
  • contracts with senior and junior members of staff

All parties should then sign the final agreement. At this point, the capital funds will be released to your company. For a management buyout, sign-off marks the point where the holding company acquires the target company.