The Good: When Cofounders Get Started
Fallon and Fernando Get Together
Fallon is an experienced engineer, and sheâs 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 â 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 wouldnât 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 heâd worked for. She gave a lot of thought to Fernandoâs 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 Fallonâs 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 âwhat-ifâ brainstorming, otherwise known as âinventing without committing.â 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 ventureâa 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 âpitch deckâ slides, and a short executive summary of how they viewed the companyâs growth potential. To allow for a longer â runway,â 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 didnât 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 angelâs effort to â anchorâ 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 angelâs 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-upâs 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 acceleratorâs 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 didnât 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 VCâs 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 âfounder reverse vestingâ and an allocation of significant equity to a future experienced âluminaryâ CEO who would be brought in after the investment closed.
The Terrible: When Dogs Eat Dogs
Fallon and Fernando Canât 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...