This article was written by the original owner of startupguide.com, Ryan Allis, and published on his website in 2012. Read more about why Ryan was happy to hand over his website domain to us here.

In a startup, your negotiating power is based on a number of factors. These include your level of need for the money, your previous business experience and success as well as the people around you and their experience. Further factors include the quality of your advisors, the product and technology, the market, the competition and particularly the competition for your funding.

Whereas it might be fashionable to go out and raise a $10 million round of funding before you even get started, and it might even be attractive if you could raise that $10 million on a $10 million valuation and only give up half of your company, I often advise people to wait in the first couple of years. Instead, get your product to market, get user feedback, improve it through rapid prototyping, and get to a minimal viable product first.

Too often I see companies raise $10, $20, $30 million before they have revenue or millions of users. I encourage you to avoid that if you want to control your company and control your own destiny.

When you receive an investment proposal from a venture capital fund, you get what’s called a term sheet. A term sheet is a summary of their desire to invest in your company and the terms at which they want to invest.

Many entrepreneurs think that valuation is the most important term and that the highest valuation is the best valuation. What I have learned in my experience as an entrepreneur is that while valuation is an important term, it is only one of many important terms. You shouldn’t simply take the term sheet with the highest valuation on it.

Let’s briefly go through each of the key terms you’ll find in a typical term sheet.

Valuation is the price at which a firm is going to invest in your company. If they’re investing $5 million at a $10 million valuation, they’ll end up owning approximately one-third of the stock because they invested $5 million in a company that’s now worth $15 million.

Option pool size is the amount of additional stock that the venture fund requires you to create in order to provide incentive structures for future employees that come into the company. For an early stage company in their early stage investment, a venture fund might require an option pool as high as 15 or 25 percent. In later stage investments, particularly once you have revenue and you’re going after your Series B or Series C, the option pool requirements are more typically in the 1-5 percent range.

Liquidation preferences defines who gets a company’s assets if it goes bankrupt and the remaining assets are turned into cash. In the case of bankruptcy, the people who provided debt (the creditors) get their money out before the people that provided equity. Most investors may want to make their investments “preferred investments,” which are senior to common investors who have have common stock – typically the employees of the company.

Founder revesting of shares is also an important term. When you, as a founder, work at a firm for a number of years, you often earn your equity over time. When you provide options and stock to employees and to founders, often you’ll provide it over the course of four years. For example, if you were to be earning 40 percent of a company’s stock over four years, you’d probably get 10 percent every year, on a monthly or quarterly basis.

Veto rights are another important topic to look at and negotiate carefully. Veto rights are what an investor can say no to and what they can stop you from doing. It’s common for investors to have a veto right on something like the sale of the company or the issuance of a lot of new debt. But you pay careful attention to what they can block, particularly if there is a block on a merger or acquisition. You don’t want a minority investor or shareholder to be able to block a deal that’s beneficial to the large majority of your shareholders.

Type of preferred stock is another term you should pay attention to. There is “straight preferred” and there’s something called “participating preferred.” There’s a world of difference between these two in terms of how much return your investors get and how much your capital costs. Make sure you read up on what “participating preferred” means and try to avoid it. Stick with “straight preferred” as much as possible.

Number of board seats is the final term you need to be aware of. Board seats are critical in terms of control of the company. If you have a five-person board of directors and you, your cofounder, and someone you know and trust have three of those five seats, then effectively you control the company, particularly if you, as the majority owner of common stock, can appoint those seats.

When you start raising investment, however, investors may want one or more board seats depending on the amount of money they’re putting in. You need to be careful because if you give up the majority of the board seats or, more importantly, the majority of the rights to appoint the board seats, you will end up being at risk of other people besides yourself being able to make decisions in your company, and even let you go as CEO.

There are some other factors, besides on what’s the term sheet, that you should consider when selecting investors, including partner chemistry, your partner’s operational experience, and networking opportunities.

One of the most important factors to consider is simply your ability to get along with the venture partner – your chemistry, so to speak. The partner, in this case, is the person who’s going to be joining your board of directors, and who is going to serve as your chief mentor during this process. Raise money from smart people you really like because, ultimately, you’re going to be more or less married to them in a business sense for the next three to ten years.

You also want to look at the partner’s operational experience. In most venture capital funds, the partners tend not to have operating experience. What that means is that they haven’t run a business or even been part of C-level team. They’ve simply been investors, financiers. If they haven’t run a company they can’t understand what it’s like to be an entrepreneur and therefore might not understand the nuance of the important components needed to mentor a new entrepreneur.

Read also: How to find a great mentor

Ask yourself if your company aligns with the fund’s other investments, known as their portfolio. Are there firms in their portfolio that you could partner with or potentially sell to someday? Pay attention to the history of successful exits from the firm and specifically from the partner that’s going to join your board of directors.

Finally, look at the venture capital firm’s network. Building your team is the lifeblood of your likelihood of success. So it’s important to work with funds and firms that have a network of operational executives at the CFO level, the COO level, or even the CEO level who they can bring in to help your company grow.

For a pre-revenue company, valuation can depend on many factors. At a tech company, a software company, or a life sciences company – the kind of company that has huge potential in the future – a pre-revenue valuation might be between $1 million at the low end and as much as $25 million at the high end.

When it comes to valuations, the old adage “location, location, location” is all too true. If you’re in Silicon Valley, between San Jose and San Francisco, valuations are often double what they are in other parts of the world.

Location is not just a matter of what’s trendy. Being in the right location is critically important because it enables you to attract better employees and executives and offers you better access to IPO and M&A markets. In areas like Silicon Valley, firms densely congregate in a way that enables you to have a much greater chance of eventually exiting the company.

Post-revenue guidelines are, of course, different than pre-revenue. Oftentimes they’re based on revenue multiples. That revenue multiple might range from 1x at the low end to 12x at the high end, depending on factors including the following: the amount of revenue, the revenue growth rate, the number of users and customers, and whether the revenue is recurring revenue. The experience of the team and CEO, the market you’re playing in and the location of your company are additional factors.

As you go about your fundraising, generally you want to create a competitive process. To do this, you need to build a pipeline of potential investors and have a number of meetings (as many as 20 or 30 meetings within a period of two to three weeks).

You may need to have initial meetings six to nine months before you’re really ready to run your process and then have those meetings again when you’re ready. You want to build your funding process to ensure that within the period of a week, you will receive multiple term sheets.

Typically, when you get a term sheet, it will only be “enforceable” or valid for a few days, so you need to drive different firms toward the same timeline and create a competitive process so that you can increase your valuation and get better terms.

When you begin negotiating valuation, as you receive term sheets, you need to have comparables fresh in your head – valuations of firms that are similar to yours. Look for companies that have had similar venture capital deals, exits, and M&A deals, and that play in a similar space to yours.

While you consider all these factors, remember that you don’t want to take a valuation that’s too high. That’s a mistake I’ve seen many entrepreneurs make. When they have a choice between raising capital on a $20 million valuation or a $40 million valuation, there’s obviously a huge temptation to raise money at the much higher valuation, because then you give up less ownership in your company and you’re diluted less.

However, when you raise money at an overly-inflated valuation, pressure from your investors to produce a return for the limited partners and general partners in their fund can create a stressful environment in which you can’t be productive. So while it is good to maximize your valuation and create a competitive process and get great terms, don’t push your investors too hard to increase their valuation.

Main photo: Unsplash/ Neonbrand

*This article was originally published on October 17th, 2018 and updated on December 11th, 2018.