This is how you negotiate millions of dollars of investment for your business

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TechCrunch has this brilliant article by James Altucher who is an investor, programmer, author, and entrepreneur. He is Managing Director of Formula Capital and has written 6 books on investing. His latest book is I Was Blind But Now I See. You can follow him @jaltucher.

When I was reading Walter Isaacson’s biography on Steve Jobs it suddenly brought back memories of the FBI repeatedly hitting the buzzer for my apartment rather forcefully ten years ago. Isaacson mentions that Steve Jobs and Dr. Larry Brilliant were best friends. Flashback to ten years ago, Larry Brilliant calls the FBI and tells them I might know something about where Osama Bin Laden keeps his money. True story.

The next thing I know, someone is ringing my buzzer, “The police! We need to come up.” Then when we let them in (after I briefly considered running down the back staircase) they flashed their badges “FBI”. They said, “we had to say “police” because we didn’t want to scare anyone on the street by saying ‘FBI’. “

Uhhh. Do you really think that is the difference between inducing fear and creating a feeling of calm?

Let’s hold off on that for a second. Three other things come to mind, maybe four, when I think of Larry Brilliant.

A) First off, what a great name. It’s like he’s a mad scientist in a Flash Gordon movie (the old black and white ones, not the one where Freddie Mercury is singing while they are flying on these weird metal wings).

B) Second, when Larry was running I had an idea for him and after all we went through (the FBI?) I thought he would respond but he didn’t

C) The most valuable thing I learned from Larry Brilliant was when we were taking a break in 1999 from looking at an ancient coin collection being held in the World Trade Center. Everyone there knew Larry and from booth to booth we were sifting through the ancient Israeli coins, coins with Alexander the Great carved beautifully into 2000-year-old silver, coins that I didn’t know the history of but Larry patiently explained.

It was beautiful, interesting, and tiring, so we grabbed a coffee , sat down at a table and I asked Larry, for lack of anything else to talk about: what is the key to great negotiation? Larry was the CEO of some public company then. A company that two years later I would help the new management liquidate but that’s another story.

The reason I asked is because I consider myself a good salesperson. I don’t have many skills, but there’s always a point with each person, on each topic, where they will say “Yes” to something. So many girls said, “No”to me in high school I had to dig deep and understand where that “yes” point was so I didn’t have to go through as much agony as an adult. [See. “7 Things I Learned from my 8 Greatest Teachers”].

Negotiation is all about boundaries and finding where to put the fence so both neighbors are happy. But when you train yourself to be too eager for the “Yes” then it becomes very hard to put up a boundary where you are saying “No”.

But negotiation is almost as important as sales. By the way, it’s not as important. Much more important to get the foot in the door (the first “yes”) then have the door slammed in your face. But once the foot is in the door you have to make sure it’s not chopped off. This is negotiation.

So I had to learn negotiation the hard way. In some cases by being out-negotiated. In some cases by observing people negotiating on my behalf (which involves more divisions in profits when you can’t negotiate for yourself) and in some cases by having a guy like Brilliant give me some tips which I remembered.

How to Negotiate:

A) Have more points to discuss than the other side.

Larry said to me that day, “most people in a negotiation think it’s just about the money. If you are selling a product it costs “X”. if you are selling a company, it costs “Y”. But that’s just a small part of a negotiation. Before you sit down for a negotiation make a list of all the things that are important to you. If you are selling a company there’s issues about salary, vacation, how long are you locked up (if it’s a stock deal), who do you report to, what your title is, how long is the employment contract for, how can you get more money if your division becomes more profitable than anyone thought, how your employees will be treated, how will your business expenses be treated, what responsibilities you have, and so on and so on. Really spend time coming up with your list, depending on the negotiation.”

Then, to make his point he reached into his pocket, in the middle of this ancient coin show, and he pulled out a dime and a nickel.

“This way,” he said, “if you have more points to discuss. You can give up the nickels.” He pushed the nickel towards me. “And keep the dimes.”

B) Have a mathematical formula. In 2007 I was negotiating the sale of my company, to I was negotiating “against” Steve Elkes, who was previously COO of iVillage and managed to sell ivillage to GE for $500 million where it was never seen or heard from again. [See also, “The Day Stockpickr was Going to Go Out of Business – a Story of Friendship”]

It was only later that I realized how genius Steve was at negotiation when he used this one simple trick. Before we started negotiating he came up with a simple formula that was so simple and made so much sense that it was easy for me to say “yes” to it as the basis of the negotiation. Only later did I realize what had happened.

He said, “Look, thestreet trades for 20x earnings. So the Board will agree to something half of that so the deal is immediately accretive.” I nodded my head. Made sense. I said, “let’s use next year’s earnings.” He agreed. Seemed simple. Steve said, “So we’ll take all of your ad inventory, take your expected users based on your current growth, use our CPM (cost per thousand impressions) since we will fill up your ad inventory, and then subtract out your expenses, which is really just your salary, and there we have your earnings and we’ll multiply that by 10.”

Simple formula. I nodded my head. He had already used one simple sub-trick against me which is not worth an entire bullet point but worth a mini bullet: “THE BOARD”. So suddenly it wasn’t me negotiating against Steve – he had an invisible backup in a worst case scenario. He put the element of fear in me. Some mysterious force, “the Board” could be erratic or foolhardy at the last minute so he would help me by coming up with this simple formula that the mysterious, and perhaps dangerous, board, would easily agree to.

So, the formula sounded like it made total common sense. Particulary since it seemed like he was on my side against “the Board”. I agreed. I immediately started adding up my numbers and thestreet’s CPM was common knowledge in their SEC filings. We agreed to meet in a couple of days while he “researched” what the CPM was and looked at my traffic numbers. All negotiators act dumb at first and as they “increase their knowledge” you inevitably get screwed.

We met again in a couple of days. This time he had the head of ad sales with him. Steve said, “I don’t know all these numbers myself but Tom can explain them.” This is another sub-point, ALWAYS ACT STUPID and defer to experts that everyone agrees is an expert. In other words, you are outsourcing the hard parts of the negotiation so you can remain “friends” with the other side.

Tom said, “The SEC filings say we get a $16 CPM but that’s wrong. We give away a lot of free ad inventory and we have sponsorships on specific sites so you have to subtract that from the $16. It’s really more like a $7 CPM.” Since I had already agreed to the “formula” that was the basis of the negotiation I was stuck trying to figure out if that $7 was real or if he was BS-ing me. But we spent an hour looking at it in every which way and $7 CPM was the number.

So I had to nod my head again.

Then Steve said, “and you really have other expenses: we’ll provide an office, insurance but let’s just focus on your salary as the expenses.” Uh-oh! He was giving me nickels to take the dimes! But he got me to feeling a sigh of relief to set me up for the fall.

“And some of your traffic growth simply comes from us sending you traffic so if we didn’t buy you, you wouldn’t have that growth. We would just send that traffic elsewhere. So we have to discount that slightly.”

By this point I was so eager to just agree to anything. I just wanted to plug the right numbers into the formula we had decided on. All the calculations I had been doing on my own went right out the window.

“So I guess the number is X”, he said.

And X it was. Since that’s what the formula spit out. About 1/3 of what I thought I was going to get but I had agreed to the formula. Touché, Steve.

The good side of that negotiation is that from that point, the entire deal closed in a week. The fastest I’ve ever seen a deal close. So I felt good about that. [See also, “10 Things I Learned from Jim Cramer”]

But the key I learned was:

Have everyone agree on a mathematical formula to value an asset or service.
Then when you start plugging in the variables, that’s where the real negotiation is occurring and if you know in advance that those numbers are going to be lower than thought, then you will win the negotiation and everyone will be happy when it’s over. It is always key for both sides to be happy at the end but since everything started off on a point of agreement, it is much easier to keep both sides happy at the end even if there is disappointment along the way.
C) Alternatives. This is obvious. But pulling it off is often difficult, particularly when you actually don’t have alternatives. You have to have guts and know how to make the other side feel fear.

In late 1999 I was negotiating with several partners on starting a venture capital firm. The firm was going to be called 212 Ventures.

Investcorp faxed us a term sheet. $100mm to start the fund, a good sized management fee and a good sized performance fee (I actually forget what they were, but assume it was the usual 2 and 20), and they would help us raise another $100mm. I immediately got down on my knees, clasped my hands together and started crying while begging Mark K (then at CSFB, now at DB) “Accept before they change their minds!”

And he, correctly, said, “just hold on a second. I want to spend a few days thinking about this.” We had no other real choices. And having a $200mm VC fund could mean a lot of money per year. Having zero VC experience it seemed like a miracle that anyone would offer me this opportunity. I couldn’t sleep that weekend, I so badly wanted to take the offer.

Mark didn’t like the deal. He again used the nickel and dime thing. He wanted us (versus Investcorp) to have more control over how decisions were made, he wanted more expenses paid for by the fund, he wanted a higher performance fee, etc. He had a list of demands much bigger than theirs.

He said to them, “listen, these guys have every private equity fund calling them. Every private equity fund realizes they missed the Silicon Valley boat and now wants in. I can’t stop them from choosing another fund but if you agree to these things, I can get them to agree.” He said again, “every single one of your competitors is calling these guys”. They weren’t but he correctly assumed they wouldn’t fact-check that.

Back to the sub-point from above, he used us as his “Board” to scare them and he also scared them with the fact that we were considering alternatives when I was on my knees and praying to god that he would just accept the offer.

Then he ignored them. They tried calling a few times. He didn’t call back. They emailed. He didn’t email back.

They capitulated on every one of his terms. We accepted. The rest of that story didn’t turn out so well. But that’s perhaps the topic for another article.

He used another trick in this: “no news” is actually “bad news” in negotiation. If someone is not responding to you, it means they are likely going to say “no” to you. He used that to his advantage to convince them that we really did have alternatives. So they became eager to capitulate.

If I had been in charge of that and just said an immediate “yes” things would’ve turned out much worse a year or so later when Investcorp was sick and tired of us (of me). [See, “My Worst Decisions as a Venture Capitalist – and 10 Unusual Things I didn’t Know About Google”]

As for Dr. Larry Brilliant, who cured Smallpox in India in the 70s, was Steve Jobs best friend, ran, and now runs Jeff Skoll’s charitable holdings, and the story of the FBI, “UBL” (as the FBI referred to Osama) and the mystery of UBL’s money, I will eave that for another story. This one has gone on long enough.

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