Fear of VCs is a common problem for first time entrepreneurs. It is a natural fear. You are going to be negotiating with somebody who is older, richer, and way more experienced in this than you are. You have heard a bunch of horror stories. They have the one thing you need to turn your dream into reality.
But chill out. Read this eight-step guide, and keep going.
Note: the term "VC" is used here to include the professional angel investors who do this for a living. They may just invest their own money, but they are in the venture investing business. This does not apply to friends and family who loan you money because they like and trust you.
Our Eight-Step Guide
1. Eliminate bad eggs early.
The vast majority of VCs are decent human beings and really want entrepreneurs to be successful. Their first duty, of course, is to their investors (and so your interests may not always align), but within that limitation they tend to be reasonable negotiators. But bad ones are out there. Eliminate them early. Check out The Funded. Ask your advisor (see step 3).
2. Understand term sheet fundamentals.
You'll need a good business advisor, and you'll need a lawyer for a final check, but you also need to understand the fundamentals yourself. Don't let yourself be confused by a lawyer because you don't know what "liquidation preference," "right of first refusal," or "drag along/tag along" means. Check out websites such as Venture Hacks. Don't waste your business advisor's time asking them to explain the basics.
3. Get a good business advisor.
You'll need an experienced entrepreneur who can help you decide what is critical (a deal-stopper) and what you can concede. Some lawyers will wade too deep into the legalese weeds and fight on points out of professional pride. You'll need someone to help you make the big judgment calls.
4. Be proactive in your reference checks.
This comes after the term sheet has been signed but before the contract. VCs do reference checks on you, and you should do the same to them. Don't worry, they won't be insulted... unless they are bad eggs that slipped through your first filter, in which case this is a great place to catch them. By being proactive, we mean selecting three companies in their portfolio to connect with. You could ask the VC for an introduction, but use your own network to connect as well.
5. Be reasonable.
If a VC sees dig-in-your-heels posturing on minor issues, they will either walk away or show you who really is the experienced negotiator with clout at the table. If you and your business advisor think an issue is a deal-stopper, calmly tell the VC why you think so. The VC would almost certainly have seen this issue before and would likely have a workaround.
6. Think clearly about valuation and dilution.
Few subjects upset entrepreneurs more than valuation and dilution. Getting some perspective on these issues and having a framework for your ongoing discussions with investors is useful. Dilution matters, and the sad reality is that entrepreneurs often end up with only a very small percentage of their company at the time of exit.
So, look at what would happen after multiple rounds of investment. Be very clear about the trade-off between scale and early profitability. Going for scale first and delaying profitability is right for some ventures; scale and the network effect are the best barriers you can erect to prevent other companies from entering the market and gaining competitive advantage. But this does put investors in control. The headline valuation number matters much less than some of the term's details, specifically the liquidation preference.
7. Make sure they have some competition.
Even the most wonderful VCs get greedy when they see a combination of awesome venture and naive entrepreneur. That is pretty rare, but if your venture gets them all excited, make sure at least three other potential buyers/investors are interested, too. VCs are like London buses: you wait and wait, and then a bunch of them come all at once.
You are either hot or not; there is no such thing as lukewarm interest. But avoid the "shopping around" posturing: you know, leaving "VC trails" in your presentation, dropping names and cards like a Victorian lady drops her hanky. Experienced VCs see through this in a heartbeat, and you'll be dead. If other investors are interested in you, their network will tell them so.
If you don't have a good VC alternative, you should know what is referred to in negotiation theory as BATNA (the Best Alternative To a Negotiated Agreement, or the course of action one party will take if current negotiations fail and an agreement cannot be reached). In simpler terms, have a viable Plan B.
8. Stay cool.
He who loses his temper first has lost. It is an old and true maxim. Very, very occasionally, a tactical bit of table-thumping will help. But getting all red in the face and looking as if you don't know whether to cry or yell won't do you any wonders.