Editor's Note: Learn from a panel of experts and entrepreneurs who have successfully financed their own ventures and are helping others do it at the Thought Leaders Live 2013 event May 29, in Long Beach, Calif. Event and ticket information can be found here.
When your business has no revenue and you have very little negotiating leverage beyond the power of your business idea, the traditional rules of negotiation just don't apply. This month's column offers some tips for the entrepreneur who's faced with the prospect of negotiating with employees, investors and suppliers during the startup stage.
Negotiating With Employees
In a previous column, I discussed how to hire and pay employees during the startup stage when you can't afford to pay market-level wages. Inevitably, however, your employees and consultants will be faced with a need for more money and will knock on your door to negotiate a better deal. How should you handle this situation?
First, you should always be respectful of the personal needs of your employees. In a small startup that's resource-constrained, employees' personal lives and professional lives are particularly intertwined. This doesn't mean giving employees a raise if they ask for it, but it does mean listening carefully to the reason for their request for more money. In many cases, they may not need more money but simply more flex time, more vacation, more upside potential, more downside protection, more respect or more inspiration. Most employees--and especially consultants--won't tell you the real reason for their request unless you ask them repeatedly in different ways to describe why they're really asking for a raise.
When negotiating compensation, it's best to link employee pay with company performance rather than just link it to employee performance during the startup stage. This puts pressure on the business model to work--so everyone gets paid--and it puts pressure on team members to hold each other accountable, because their compensation is linked to each other's performance.
The downside of this incentive structure is that you may have a top-performing employee who doesn't get a salary increase or bonus because of execution problems among his or her colleagues. You should deal with this on a case-by-case basis and may want to provide occasional bonuses for exceptional performance. In practice, giving employees a gift certificate for a trip or an expensive dinner out for their family and friends may provide a better incentive than a cash bonus pool that becomes the source of tension among employees. In a small startup, a cash bonus pool to be divided among employees is a bad idea and undermines the base compensation levels you've negotiated with them.
Negotiating With Investors
Traditional negotiation theories tell you to understand your BATNA--or Best Alternative to a Negotiated Agreement--before you begin negotiations. Unfortunately, for most cash-strapped startups seeking capital from investors, your BATNA is going out business! So a negotiation theory for startups requires a different approach. Here are some tips for negotiating with investors when your BATNA is closing shop and going back to a 9-to-5 job:
1. Never let them see you sweat. Investors will only put money in a company if the entrepreneur is confident of the company's prospects. They might know you have few alternatives for startup financing, but when they see your confidence, they'll temporarily forget about those other options.
2. Draft the investment terms before the meeting. It might be putting the cart before the horse, but it's critical to have investment terms clear in your head before you meet with investors. If you're pitching venture capital investors, get familiar with term sheets before you walk in the door. If you're raising money from relatives, friends or other business angels, read this column for tips on how to make the pitch and structure the investment options.
3. Tell minority investors that you have standard terms that are non-negotiable. Don't let investors restructure your investment terms unless they plan to lead the entire round of fundraising. Most investors will actually prefer you to have standard terms so they can focus on evaluating the business proposition rather than the investment terms. Avoid the temptation to negotiate individual terms with each investor because it will likely cause you headaches down the line when certain investors are paid back before others.
Negotiating With Suppliers
During the startup stage, it's almost always a problem to negotiate favorable deals with suppliers. How can you strike a deal for a volume discount when you can't accurately forecast sales volume? How can suppliers provide you with credit when you don't have a track record with other suppliers?
I recommend negotiating with suppliers just like you'll negotiate with investors: Put your best foot forward, and let them believe in your company as much as you do. For instance, let your suppliers dream of the day when you'll be their biggest customer. Negotiating a deal on favorable terms will be considerably easier when they perceive your business as a potential long-term client rather than a startup.
One concrete way to accomplish this with a key supplier is to extend the duration of your order rather than just negotiate on price--and, to protect yourself, by adding termination provisions to the contract. Suppliers and their sales staff are more likely to provide a favorable price for a long-term agreement with a termination clause rather than to a small, low volume order. For example, if you're reasonably confident in your business's growth potential, try ordering three years' worth of supplies rather than a one-year supply. But be sure to spread out the payments over the life of the contract and add in an enforceable termination clause.