Negotiating your Seed round

War stories from the jungle

Amidst the chaos of the biggest tech conference of Singapore, I somehow got hustled today into moderating a session with two very cool people from the industry: Tiang Lim Foo from SeedPlus and Grace Sai from The Hub. The topic of the discussion was “How to Negotiate your Seed round” and we tried to do justice to this really intense topic that is quite close to my heart in the 30 minutes that we were given. I think in the end we ended up just brushing the topic lightly, so I wanted to do a deep dive here.

I’ll stick to what David Corbin from TechInAsia suggested we talk about, although we can just go on and on about this subject. So here we go.

What terms are most important for founders and VCs?

It’s a very basic question that David asked but I feel it’s the most important one. I started off by asking Tiang and Grace firstly what is the motivation of both the founders and the investors when going into a negotiation. What’s at the back of each one’s mind, what are they aiming to achieve? Tiang had a fair point that whatever be the motivation of the founder, it should actually be to try and find a long term partner who can work with them in the long run. While Grace associated this more to dating, Tiang mentioned it was more of a marriage. I agree with both, but want to expand further.

The motivation in my opinion usually ends up being slightly different for founders and investors. While both are optimising for their personal ownership in the company, more often than not, the founders end up being short-sighted in their approach whereas the VCs always think a bit longer-term. The founders are pretty happy if they can walk out of the deal with a good valuation, ticket size matching what they wanted to raise, and founder-friendly terms. The VCs however end up spending a bit more time thinking how the company will evolve in the next 12–24 months and what are the downside and upside protections they need to put in place to maintain a healthy ownership in the company. Hence come in the anti-dilution rights and ROFRs and Pre-emptive clauses. This adjacency of intent is something a founder should think of before walking into that negotiating meeting. And during the meeting, pay close attention to the terms and points important to the investor, and use these to negotiate what you want from them.

Further elaborating on the valuation part, I asked Grace and Tiang how they value or price a seed-stage company. Grace mentioned that they usually start off with a typical seed stage valuation, say $1.5M, and then either go up or down depending on various factors such as serial entrepreneur, strong team, early traction etc. I think that’s a fair way to value and ends up being what we call a Comparable Approach. Company X in this space in the same market with similar kind of customers raised at Y valuation. Hence you should be somewhere around the same number.

Lastly for this topic, I wanted to understand what according to the two investors was a standard term sheet for a Seed round in this market. While both Tiang and Grace avoided the question (likely because of time constraints), I want to expand on what we are seeing in the market and the term sheets we are writing. I think SAFE and KISS have put out a very good template for a term sheet out there. However, as I have mentioned before, I am not a big fan of raising Seed rounds on Convertible Notes. At GREE Ventures, we try to combine the best of both worlds, as we like to do equity rounds with plain vanilla terms. These are 1x Non Participating Liquidation Preference, Broad-based Weighted Average Anti-Dilution, Pro-rata ROFR and Pre-emptive rights, Tag Along, Drag Along and that’s it. We like to take a board seat if our ownership is above 10%, and like to have a fully-diluted ESOP pool set up along with founder vesting. I would like to talk about the ESOP pool and founder vesting in another post in detail, as this has been a topic I have been discussing with a company lately.

How can your seed deal negatively/positively impact Series A?

In continuation, next up was a question regarding the big no-nos that turn a Series A investor off. Tiang mentioned that there should always be an eye out on the metrics you need to hit for your Series A and then you should work backwards to figure out what should be your funding raise and valuation to hit those metrics. Grace explained this a bit more, talking about how it’s important to not price your Seed round too high, lest the high valuation scares off the next round investors. I do agree with both of them again and want to expand a bit more on the cap table side.

We have had a case where our portfolio’s cap table didn’t look the prettiest under the sun. And this was again due to the damned Convertible Notes which got layered at multiple valuations. The other reason for the cap-table-ugliness in the same company was not a proper vesting period for the top management because of which when someone from the top management left the company she ended up still holding a decent chunk of shares. While this is not a make-or-break scenario for the company it does impact the next funding round and I have been told by the next round guys that the cap table being ugly was one of the reasons they passed on the deal. Thankfully, we have fixed some of it now and the company has gone on to raise the next round, but it made things definitely more difficult.

How are negotiations in 2017 different from 2016?

While Tiang and Grace didn’t want to share too much on this topic, I had an interesting tidbit to share. Early morning I woke up to do some crunching of our internal fund database where we record all our meetings and company revenues, valuation expectations etc. I did a quick pivot table and found that the seed stage expected valuation from the founder side has been going down significantly since 2015. And it continues to remain low in the early part of this year, so we are definitely in a downward half of the cycle.

Closure

We didn’t get a chance to discuss this, but I wanted to point people to two key resources: Venture Deals and AVC.com for further material on this topic. I also wanted to leave two practical tips when walking into a negotiation meeting, and sorry if this sounds a bit MBAish.

BATNA: Best Alternative to a Negotiated Agreement

This is probably Negotiations 101. Each party should always go into a negotiation knowing what their BATNA is. For a founder the BATNA can be a better valuation they can get from angels, potentially bootstrapping for a bit longer, or any other funding options. But it’s not so difficult to calculate your BATNA and then you know what deal to walk away from. Signaling that you have a strong BATNA (if you actually have one) is a good way to proceed on the negotiations faster as well. Do some homework on this and spend time figuring out this number.

Anchoring Bias

This is a more subtle one and people can agree/disagree. It’s usually always good for founders to set a high anchor for the valuation when starting to negotiate. Whoever sets the anchor first usually ends up walking away with the bigger piece of the stick. This is a known bias in negotiations and you can read some more on it here. A word of caution here, the anchor needs to be realistic else the other party feels you are not being serious or haven’t done your homework or just overall difficult to work with. So when the VC asks you for your expected valuation, be ready with an answer and set the bar high.

Just to end off, reiterating what Grace and Tiang stressed upon during the session, it’s best for the founders to find and optimize for good investors to work with, and valuations and negotiations are only a small hurdle along the way. Half a percent here or there doesn’t matter in the long run anywhere as much as working with some one you can trust and who you know can add value to your business.