Entrepreneurial Negotiation: Understanding and Managing the Relationships that Determine Your Entrepreneurial Success

By Samuel Dinnar, Lawrence Susskind and Edward Roberts

The great majority of startups fail, and most entrepreneurs who have succeeded have had to bounce back from serious mistakes. Entrepreneurs fumble key interactions because they don’t know how to handle the negotiation challenges that almost always arise. They mistakenly believe that deals are about money when they are much more complicated than that.

This book presents entrepreneurship as a series of interactions between founders, partners, potential partners, investors and others at various stages of the entrepreneurial process - from seed to exit. There are plenty of authors offering ‘tips’ on how to succeed as an entrepreneur, but no one else scrutinizes the negotiation mistakes that successful entrepreneurs talk about with the authors.

As Dinnar and Susskind show, learning to handle emotions, manage uncertainty, cope with technical complexity and build long-term relationships are equally or even more important. This book spotlights eight big mistakes that entrepreneurs often make and shows how most can be prevented with some forethought. It includes interviews with high-profile entrepreneurs about their own mistakes. It also covers gender biases, cultural challenges, and when to employ agents to negotiate on your behalf.

Aspiring and experienced entrepreneurs should pay attention to the negotiation errors that even the most successful entrepreneurs commonly make.

• Language: English
• Publisher: Palgrave Macmillan
• Release date: Aug 16, 2018
• ISBN: 9783319925431

Book preview

© The Author(s) 2019

Samuel Dinnar and Lawrence SusskindEntrepreneurial Negotiationhttps://doi.org/10.1007/978-3-319-92543-1_1

1. Entrepreneurship: The Good, the Bad, and the Terrible

Samuel Dinnar¹   and Lawrence Susskind²  

(1)

Program on Negotiation at Harvard Law School, Cambridge, MA, USA

(2)

Department of Urban Studies and Planning, Massachusetts Institute of Technology, Cambridge, MA, USA

Samuel Dinnar (Corresponding author)

Lawrence Susskind

Keywords

Co-foundersAngel investorsTerm sheetVenture capitalists (VCs)Start-up relationshipsEntrepreneurs emotions

The Good: When Cofounders Get Started

Fallon and Fernando Get Together

Fallon is an experienced engineer, and she’s patented a brilliant new invention.

Fernando is a seasoned business executive with significant marketing and sales experience. He is looking for his next business opportunity and has enough money to potentially invest in a new venture. Fallon has a working proof-of-concept prototype, a good business plan, and a carefully polished pitch. A former colleague introduced Fallon and Fernando at a dinner party. They had a great conversation, liked each other, and realized that they could create a lot of value by working together. They agreed to explore starting up a new company.

Before their first meeting, they each took time to prepare. They wanted to be very clear about their interests, that is, the kinds of things they valued most highly. They thought hard about their walkaways – the point at which they would walk away rather than accept a deal. Their two walkaways set the edges of what negotiators call the trading zone or the zone of possible agreement (ZOPA ).

Fallon talked with her trusted business advisor. They estimated the likely commercial value of the company she hopes to create. Her advisor encouraged her to think hard about what her minimally acceptable deal would be and taught her to call it her Best Alternative to a Negotiated Agreement (BATNA). She promised her advisor she wouldn’t make a final commitment before checking back and also checking with her lawyer . Together these are her back table. Fallon also tried to learn as much as she could about Fernando and the other companies he’d worked for. She gave a lot of thought to Fernando’s likely interests and BATNA .

At the same time, Fernando did his due diligence. He gathered all the information he could find about Fallon and her invention. He described to his mentor what he knew about Fallon’s invention. He gauged the level of interest of several former clients who might be customers if he moved in this new direction. They encouraged him to explore the possibility of a deal but make no firm commitments. These are his back table members.

Fernando and Fallon considered using agents to represent them. Fallon was worried she might not have enough experience to represent herself effectively on financial questions, and she worried that she might let her emotions get the better of her. Fernando worried that he might not have sufficient mastery of the relevant technical issues. He knew that no matter how much experience he had, certain biases might cause him to misread what Fallon is trying to communicate.

Fernando and Fallon agreed to an agenda for their meeting. It included items covering what they would each contribute to the company, the valuation of their possible joint venture, how they would split whatever money they made, and how they would handle the risks that could not be avoided. Fallon and Fernando each tried to clarify for themself what they would be willing to offer in exchange for other items that were highest priority for them.

When they finally met, together with their agents, they began by talking about how they were going to negotiate. That is, they specified the ground rules they would follow and the rules of confidentiality that would apply. Once they got to the heart of their agenda, they realized that they disagreed, rather sharply, about the size of the market for the products and services they had in mind. They also disagreed on the equity stake Fernando would receive and the vesting that would apply; that is, the share of the company he would get to own over time and the portion of his promised equity share he would receive if he left early. They realized they had to revisit their process of negotiating. They agreed to a follow-up joint fact-finding effort to gather additional information they both could trust. They also explored some possible contingent agreements that would allow them to proceed, even given their different estimates of the future. They did a lot of what-if brainstorming, otherwise known as inventing without committing. For each agenda item, they reviewed numerous options and prioritized which were most important. Then, they explored various packages of options and considered additional trades that would make each possible deal better for both of them. Finally, they talked about a dispute resolution clause they would include in any agreement so that any disagreements that emerged could be resolved quickly.

In the end, after several meetings and a chance to confer with their back tables, they reached a deal. Fallon was confident the deal was in her negotiation sweet spot. It promised quite a bit more than her BATNA and came close to fulfilling all of her aspirations. Fernando also got a deal that his back table supported. He and Fallon created value by including numerous contingencies and guaranteeing how control over key decisions would be shared going forward. Fernando decided that the package was worth it, even though he did not get everything he wanted. He was guaranteed the level of control and the potential upside rewards he needed to justify the risks he would have to take.

Fallon and Fernando were tough on each other, but they listened carefully and maintained a respectful dialogue. They found things to trade and they created value. They came away happy and signed an agreement. They are now cofounders of a seed stage company, and they have a relationship that will allow them to work together as they move ahead.

The Bad: When Angels Sing and Investors Dance

Fallon and Fernando Make Mistakes

Fallon and Fernando selected a name for their seed stage company. Fernando convinced his uncle to invest in the new venture—a sum that allowed them to pay themselves modest salaries for the first few months of operation. Fallon was thrilled. Together, they turned their vision into a business plan, a set of pitch deck slides, and a short executive summary of how they viewed the company’s growth potential. To allow for a longer runway, they approached a well-known angel investor who understood their market and vision. The angel decided to invest a substantial amount but argued for a low valuation of the start-up. Fallon and Fernando were hesitant. They didn’t want to give up such a significant share of their company to the angel. So, they made a high counteroffer in response to what they viewed as the angel’s effort to anchor the negotiation at a low level. After some back-and-forth in person, and additional haggling over email, they compromised on a valuation somewhere in the middle. When the angel’s lawyer sent a short investment agreement letter, Fallon was uncomfortable with some of the terms, especially one that gave the angel veto power over decisions about the choice of future investors. She discussed this with Fernando, and they decided to avoid further conflict by accepting the terms suggested by the angel.

Encouraged by their progress, with resources to implement their plans and improve their marketing material, they presented their pitch at a local start-up competition. They won first prize! Their award included a three-month stay at a famous incubator where they could continue to develop their ideas and expand their professional network. The angel convinced one of the best venture deal lawyers in the area to provide Fallon services at a reduced rate. The paperwork was completed efficiently, but since Fernando could not travel for personal reasons, he stayed behind. He participated in meetings via phone and videoconference. With the intense pace of events in the famous incubator, Fallon was forced to make a great many decisions on her own. Fernando focused on product development, talking with new local contractors and possible hires. He met occasionally with his uncle and the angel. After one such meeting, he informed Fallon by email that they did not approve of one of her recent decisions. She was surprised, but decided not to make a fuss. Over the next few weeks, additional control issues emerged that were not dealt with very well. But these tensions were overshadowed by the influx of good news. Fernando was able to convince one of the best software developers in the area to accept an executive position. His decision to join, along with the simultaneous hiring of other good developers, increased the chances they would have a great product. It also affirmed the start-up’s image as a highly promising place to work. Fernando completed the necessary reference checks and was able to sign their new senior executive, offering a generous equity share in writing, along with some verbal commitments about near-term salary and title improvements. Meanwhile, Fallon was working hard. Drawing on the accelerator’s amazing professional network, she was able to close a deal with their first customer! While Fallon felt that Fernando had offered his new hotshot developer a package that was far too generous, Fernando felt that Fallon had overpromised their new customer on features and an overly optimistic delivery schedule. The customer was not even in their target beachhead market. But they didn’t have time to worry about these things. Their excitement skyrocketed when a major venture capitalist (VC) expressed interest in their start-up. They talked for hours about how they should revise their pitch and marketing material to reflect their emerging organization and what they saw as the promise of future products, customers, and revenues. They basked in the external validation they had already received: their start-up competition award, participation in the accelerator, the hiring of a star developer, and, most importantly, a signed purchase order from a respected customer.

Their in-person pitch to the VC went very well. It was followed by several long meals and meetings with the partner. Fallon and Fernando were euphoric when they received a multimillion-dollar investment term sheet via email! After a champagne toast, they turned to some of the less-favorable items included in the term sheet. The most problematic was the VC’s desire to have one of them relocate to be closer to their primary market. The VC also wanted them both to agree to something called founder reverse vesting and an allocation of significant equity to a future experienced luminary CEO who would be brought in after the investment closed.

The Terrible: When Dogs Eat Dogs

Fallon and Fernando Can’t Manage

Fallon and Fernando each reviewed the multimillion-dollar term sheet they had received from the VC. In the days that followed, the VC continued to call each of them with questions about various due diligence items. Fallon used these conversations to understand more about the proposed terms of the deal, including the relocation requirement and its implications. Also, Fallon tried to find out more about the VC’s thoughts regarding the luminary CEO’s credentials and when this person would start. In parallel, Fernando scrambled to come up with answers to the VC’s many questions about product features and the market. He, too, used these calls to raise questions about the future CEO bringing in his own marketing and sales people (including someone who would take Fernando’s position).

To impress the VC, the cofounders pushed their team to accelerate product milestones, increase their marketing efforts, and step up onsite sales efforts with possible customers. During one trip, Fallon and Fernando finally marked up the term sheet with their red-line edits (including suggestions from their lawyer). They sent it to the VC. They rejected the founder shares reverse vesting, reduced the future CEO equity allocation, and added language to ensure they would have a role in the future CEO selection process. The VC replied a few days later, insisting that the original term sheet was nonnegotiable.

In a meeting back home with their angel investor, the cofounders described all their VC interactions and admitted they were running low on cash. After being pushed by the angel on this point, they agreed to discuss their budgetary woes at a formal board meeting with the lawyer present. At the meeting, the founders proposed to push forward as planned, indicating their intention to defer some payments and salaries until after the round closed, as a way of conserving cash. The angel insisted on reducing the headcount (terminating half of the employees immediately), slowing development, reducing marketing efforts, and looking for a different VC. When the angel expressed some strong concerns about the particular VC that Fallon and Fernando had already decided to work with, they argued that they were impressed with the VC. The angel investor reminded them that the executives’ primary duty should be to manage the cash situation and that he had veto rights that could be exercised against this or any other VC. The cofounders were shocked by this threat. They were stunned when the lawyer sided with the angel. The meeting ended on a very tense emotional note.

The next day, Fernando shared what was happening in a meeting with his star developer, who immediately asked for an increase in salary. He wanted to be paid more, not less, for the time he was investing. In addition, the developer said, There is no way that I will agree to stay here unless the full team is kept on-board. I have plenty of offers that would pay me more and provide me a larger team of talented developers. When Fallon heard about this from Fernando, she felt betrayed by both the star developer and Fernando, who had made lots of promises to the new hires without telling her. She blamed Fernando for the situation they were in. He accused her of having fun at the accelerator while he was busy building the company. Fallon called him a narcissist who had forgotten that she had to be out there on her own doing all the marketing that he was supposed to do. She taunted him by reminding him that she was the only one who had closed a sale. Fernando challenged her on that point, arguing that with the unrealistic terms and penalties she had agreed to, they would have been better off without the sale.

The next day the angel came up with a proposed solution. He would invest more money in an internal round that would carry them through the short period until they could find a different VC. He emailed Fernando and Fallon a term sheet that their lawyer had put together. It lowered the valuation of the company still further (much lower than what the prior angel investor had suggested and included significant equity for the star developer who would be named a cofounder). The additional investment would allow the entire team to remain onboard. Naturally, this down-round came at the expense of a huge dilution of the founders’ equity holdings.

Fallon was not willing to give up control of her baby. She was outraged at what she saw as a coalition forming against her. She called the lawyer , accused him of being a double agent, working for the angel instead of for the good of the company. She exercised her CEO right to send a termination email to the star developer. Fernando was deeply offended. He called a shareholder meeting to issue Fallon an ultimatum. Fallon hired a new lawyer to represent both her and the company, while informing the angel’s lawyer that he was terminated as the company’s lawyer. She also threatened to sue the lawyer for malpractice due to a conflict of interest.

Fernando and Fallon confronted each other at the office (and all the employees could hear them yelling behind the closed door). Fallon used her CEO authority to send Fernando a two-week termination notice effective immediately, before any of his cofounder equity became vested. The cofounders continued to accuse each other of lying and blamed each other for the situation they were in. Everyone was eventually forced to take sides, and productivity came to a halt.

Despite their differences, Fallon and Fernando decided to make one last call to the VC. They were ready to accept all the VC’s proposed terms, provided they could close quickly (since they were in dire need of cash). During the call, they hinted vaguely that some internal issues had arisen and they would need help dealing with an angel investor who did not favor the terms specified by the VC. The VC promised to call them back. A few days later, the VC indicated that his partners had decided that while they liked the company, they were going to focus their efforts elsewhere. He suggests they stay in touch since his partners might eventually come around. Fernando suggested via email that the VC reconsider, indicating his willingness to provide additional upside terms and a lower valuation. He did not get a reply.

The start-up ran out of cash and was forced to send termination notices to all of its employees. A take-it-or-leave-it offer from the angel investor to acquire all the assets of the company for a token amount was rejected by Fallon. The company was forced to close.

How to Use This Book

At this point, we hope you are not so depressed by the story of Fallon and Fernando that you stop reading. Naturally, our intention is not to discourage you from being an entrepreneur. In fact, in a few paragraphs you will see an alternative happy ending to the Fallon and Fernando story, one that embodies better negotiating practices and achieves a better outcome.

The truth, though, is that most start-ups fail. Entrepreneurs make negotiating mistakes that threaten their success. In this book, we will reimagine entrepreneurship and help you prevent making as many of these mistakes as possible. However, realizing that mistakes of this kind are almost inevitable, we want to help you minimize the damage and show you how to respond once any of these mistakes are made.

Following this introductory story, there are six chapters. The first two describe the entrepreneurial world as we see it. We offer a roadmap that highlights the key negotiations that characterize the life of a start-up, generate pressures on the founder, threaten the relationships that must be forged, and constrain interactions with investors, suppliers and customers. One of the features of Chapter 3 is our list of the eight worst mistakes that entrepreneurs tend to make. Chapter 4 summarizes a number of real-world entrepreneurial cases that indicate how and why things go wrong. You will hear from a diverse group of successful entrepreneurs, with different personalities and styles, who come from different cultures and industries, talking about the mistakes they have made. These are reflective individuals, and we are grateful for their willingness to share their entrepreneurial adventures and their negotiation failures so that others can benefit.

In Chapter 5 we show how entrepreneurs can do better by sharpening their self-awareness, situational sensitivities, and communication skills. Chapter 5 also introduces the world of entrepreneurship reimagined through the lens of relationships and negotiation. We indicate ways of preventing the worst negotiation mistakes before they occur by planning properly. We propose ideas about how to detect mistakes just as they are about to happen. And, finally, we explain how to recover when mistakes are made.

We close in Chapter 6 with a call for you to reflect on your personal theory of practice (TOP). This will make it easier to learn from your own experience, soar with your strengths, and develop and support your team. We provide advise on how to do each of these things and encourage you to spread the word so that entrepreneurial negotiations will become easier for others. Finally, in the Appendix, we provide you with various Worksheets that will facilitate the practical implementation of what you learned in the book into your own entrepreneurial projects, allowing you to develop and adjust your own personal TOP.

Something Better: An Alternative Good Ending

In the alternative version of the story, Fallon and Fernando are able to avoid the mistakes that did them in, and when they do make negotiation mistakes, they are able to recover quickly. We pick up the story immediately after Fallon and Fernando received the term sheet from the VC.

Fallon and Fernando Score a Win

Fallon and Fernando selected a name for their seed stage company, and are excited about the future. Fernando convinces his uncle to invest a sum that will afford them modest salaries for a few months of operation. Fallon is thrilled, but meets with Fernando’s uncle herself, including one session with her lawyer present, to align expectations. She does not agree to take any of Fernando’s uncle’s money until her lawyer completes some critical paperwork. Fallon and Fernando turn their preliminary vision into a business plan, a set of pitch deck slides, and an executive summary of the company’s future growth potential. To allow for a longer runway, they approach a well-known angel investor who understands their market and vision. The angel decides to invest a significant amount but suggests a low valuation.

Fallon and Fernando arrange a series of meetings to explore the angel’s interests, understand the concerns behind them, and explore alternatives that would meet the angel’s interests in a way that would be better for them as well. After building a modicum of trust, consulting their lawyers, and looking at comparable investments, both sides reach agreement on a valuation they all think is fair, as well as terms that are typical for such investments. The angel’s concerns about having a say about future investors are addressed by establishing an inclusive process, but without giving the angel veto power.

After winning first prize at a local start-up competition they are awarded a three-month stay at a famous accelerator at a distant start-up hub. They need some urgent legal work done and consider the angel’s generous offer to have his top-notch lawyer work for them on their corporate paperwork. In the end, they turn down the offer because of potential conflicts of interests. Fernando informs Fallon that he cannot travel to the accelerator for personal reasons. He and Fallon negotiate clear roles and responsibilities for the three-month period Fallon will be at the accelerator. Fallon keeps Fernando updated almost daily about the fast-paced discussions in which she is involved, and Fernando updates her on product development progress as well as with his conversations with newly hired local contractors and employees. While they make each other angry now and then, they find a way to share how they are feeling. This leads to a growing understanding between them. It also allows them to explore continuous changes in how they work together and keep each other informed. When Fernando finds out that Fallon is presenting herself as the founder of the company, he senses a lack of appreciation and is worried about his status. He lets her know this, and Fallon promises to pay more attention to using the term cofounder. They commit to making all the important decisions together, and insist on scheduling formal update meetings on a regular basis with the angel investor (and at a lesser rate, with Fernando’s uncle). They make a habit of sending weekly email updates to their investors and lawyer , which they both edit.

They face an influx of good opportunities. On some they decide to pass due to bandwidth issues – there is only so much they can do. Fernando is able to convince one of the best developers in the area to accept an executive position. Fernando knows he has a tendency to fall in love, and is concerned about overpromising in order to close the deal. So, after completing the proper reference check, he follows a predetermined procedure to get Fallon’s agreement with the terms he is offering and the expectations they are setting jointly (just as he has done with all recent hires). He uses a human resource (HR) consultant to ensure that he does not cave in to last-minute demands once he is emotionally attached to a candidate. After conversations with both Fernando and Fallon, the star developer joins the team with a well-defined role, clear expectations, and plans for the best way of communicating with both of them. Meanwhile, Fallon works hard to leverage the accelerator’s network. She receives strong interest from a customer who is ready to issue them their first purchase order! Fallon knows that she tends to be too optimistic when it comes to sales. She does not have a lot of experience dealing with commercial sales, guarantees, and product delivery schedules. So, she asks a colleague from the accelerator to come with her to observe her meeting with the potential customer, and to help her make sure she does not make inappropriate commitments. She videoconferences with Fernando, and together with the colleague they run a dress rehearsal of how the meeting with the customer might go. They are able to secure a tentative purchase order for what looks to be an appropriate amount, but it includes contingent terms that will allow them to cancel or delay deliveries with no