Negotiation and deal structuring in venture capital and angel financing

A literature review of Negotiation and Deal-Structuring phase of Venture Capitalists and the Business Angels




Tryambaka Mahapatra

Asst Professor- Finance

School of management

KIIT University, Bhubanewar

Emil- tsmahapatra@ksom.ac.in

Phone- 9776129109



Abstract

This paper reviews the literature on negotiation and deal structuring phase of business angels and VCs. Both the types of investors play a dominant role in the private equity market. But the inefficiency of the market makes negotiation of the deals a very cumbersome issue. This paper deals with some of the nuances of venture capital and angel deals. The outcome of the review is expected to inform entrepreneurial community, academics and policy makers in the area with tricks of the trade. It is also expected that valuable research questions would arise out of this review and they will guide more and more researches in times to come.



Key words- Business Angels, Venture Capitalists, Deal structuring and negotiation.



Introduction

This paper reviews the literature on negotiation and deal structuring phase of the venture capitalists (VCs) and the business angels (BAs). The motivation for this review is the growing importance of private equity in the economic rejuvenation of national economies, and the importance of deal negotiations and structures in this market. It is to be noted that the micro and small enterprises (MSEs) worldwide have been accepted as an engine of economic growth and are made accountable for promoting equitable development. The MSEs constitute over 90% of total enterprises in most of the economies, and are credited with generating very high rates of employment growth, large chunks of industrial production and exports. In India too, the role of MSEs in reviving the industrial growth is predicted to be substantial. It is estimated that in terms of value, the sector accounts for about 39% of the manufacturing output and around 33% of the total export of the country. But, the problem is that the small and especially high growth businesses are very much prone to resource constraints (Audretsch 2002). The reasons for this are many and mostly obvious. Small firms have any way access to several unique equity and debt sources, and the sources and composition of their financing mix changes as they progress through various stages of development (Walker 1989). In the context of small businesses different types of equity providers have been identified; they are VCs, private corporations, investment bankers, consultants and other private investors (Hustedde and Pulver 1992). This paper discusses only about the negotiation and deal structuring phase of VCs and the BAs (BAs are the high networth private individuals). The review is done under four sub-sections. These are process of negotiation and deal structuring, valuation of deals, shareholding structure and restrictive covenants in the deals. It is expected that the outcome of the review will familiarise academics and practitioners in the field with the subject, give new impetus to research in the area and will also guide policy makers.



4.1 The process of negotiation and deal structuring

Private equity negotiations are not zero sum games, and an investor endeavours to align his incentives with those of the entrepreneur through proper negotiations (Moon 2006). The existing literature on negotiation and deal-structuring phase of angels has attempted to explain significance of this stage mostly from the perspective of agency theory (Landstrom et al. 1998, 2005 and Kelly and Hay 2003) and social exchange theory (Landstrom et al. 1998, 2005). The negotiation and deal-structuring phase of an angel investor (described as a “friction process” by Landstrom et al. 1998) are characterised by valuation of an investee business and deliberation over terms and conditions of an investment that includes an investor’s post investment role (Haines et al. 2003, Mason 2006a,b). Haines et al. (2003) note that angel investors at this stage consider it important to meet principals of the firms in which they might invest and get to know them over a period of time. An angel negotiates his deals after he is satisfied through due diligence about the investment worthiness of an opportunity (Dal cin et al. 1993, van Osnabrugge 1998, van Osnabrugge and Robinson 2000, Benjamin and Margulis 2001, Mason 2006). Once a deal reaches the negotiation phase of an angel, record Dal cin et al. (1993), the probability of its getting funded (or unfunded) becomes 50%. Dal cin et al. cite a number of issues that could act as deal breakers at this stage, and these include pricing of the deals and ownership, angel’s personal chemistry with an entrepreneur, and any unwelcome information about the venture that an investor was hitherto unaware of. The time for negotiating deals, according to Sohl and Areson-Perkins (2001), is more for the early stage ventures than for the late stage ones. According to Benjamin and Margulis (2000), negotiation phase of angels is not a smooth one, and could be marked by protracted delays and unyielding attitudes by both parties over valuation issues. An investor and an entrepreneur according to them “dicker over fair market value” of a venture. The significance of a well structured deal for an entrepreneur lies in assuaging his “extreme reluctance” to approach a third party for funding, who could potentially infringe on his independence in a later period (Manigart and Struyf 1997). The sensitive issues of ownership and control of a firm between an entrepreneur and an investor dominate discussions at this phase (Gaston 1989). Sohl and Areson-Perkins (2001) note that angels negotiate deal structures according to their individual sets of criteria and preferences, and it is thus hard to find out discernible patterns in their deals. Some angels in order to negotiate and structure deals initially present term sheets to entrepreneurs. According to Sohl and Arenson-Perkins (2001) and Sohl (2004), the comprehensiveness of a term sheet issued by an angel varies from deal to deal; some might not lead to written agreements at all, whereas some might end up with highly complex agreements or contracts.



Mason and Harrison (1996) in a study of angel investment process in the UK observe that nearly 70% of their respondents signed investment agreements (or contracts); these mostly included the monetary amount of investment, share holding structure (e.g. equity splits, preference or ordinary shares and ratchet mechanisms), exit options, debt structures of the companies, warranties and promissory notes written by owners. Some of the more detailed investment agreements of their respondents, they observe, included provisions relating to employment contracts of entrepreneurs, entrepreneurs’ remuneration, fees of directors and restraints of the trade. According to Mason and Harrison (2002), many angels fail to do a deal as they are unable to reach an agreement over terms and conditions that involve it. Their study provides a percentage break up of a number of parameters involving deal structures that led to the rejection of the deals -pricing (50%), share holding structure (44%), composition and power of the board of directors (18%), post investment role of the investors (15%), exit strategy (9%), remuneration issues (6%), veto rights of investors (3%), and etc. The various parameters cited above are essential ingredients in an investment contract.



An investment contract, according to Landstrom et al. (1998), helps investors establish “transactional parameters” of a deal. Gompers and Lerner (2002, p30) state “the terms and conditions that govern the contractual relationship between (any of) the two parties are critical in limiting opportunistic behaviour and ensuring allocational efficiency.” In general, contractual arrangements involving a start-up are mostly incomplete due to the inherently risky and uncertain nature of them (Bhide 2000) . The incomplete nature of investment contracts between an angel and an entrepreneur has been commented upon by van Osnabrugge (1998) and Kelly and Hay (2003). van Osnabrugge (1998) notes that many of his respondent angels in his study were not concerned about the inclusion of contractual clauses in their investment agreements they signed, but the risk and success parameters of the business. van Osnabrugge and Robinson (2000) note that investment contracts between an angel and an entrepreneur should be signed on a “give and take” basis. Sohl and Areson-Perkins (2001) note that contract terms and conditions help investors establish effective control over entrepreneurial ventures, and it is the early round angel deals that contain more terms and conditions. Kelly and Hay (2003) test a number of hypothesis related to investment contracts signed between an entrepreneur and an angel, and arrive at a number of useful conclusions. First, they find modest evidence that angels would strike tighter contracts with entrepreneurs when the latter are more industry savvy than them and vice versa. Second, they find strong evidence that investors with a high desire to play a value added role in their investee businesses will structure the inclusion of their post investment role and responsibilities in their contracts. Third, they find strong evidence that syndicated angel deals will strike tighter contracts than individual angels. Fourth, they did not find support for their belief that bigger deals involved tighter contracts. Fifth, they found strong support for the notion that tighter contracts are struck when angels retain larger equity stakes. Sixth, they found strong support that deals that are referred to angels by trusted sources involve looser contracts. Sohl and Areson-Perkins (2001) note that various contractual terms and conditions (like, board representation, anti-dilution rights, drag along rights, piggy-back registration rights) help angels establish effective control over entrepreneurial ventures, but it is the early round deals that contain more terms and conditions. Kelly and Hay (2003) further note that five contractual provisions are very important, and therefore are non-negotiable for the angels- these are veto rights over acquisitions/ divestitures, prior approval of strategic plans and budgets, restrictions on management’s ability to issue share options, non compete contracts in the event of an entrepreneur’s termination of employment, restrictions on the ability to raise additional finance. They nevertheless add that contractual provisions that are less important for angels, and thus are negotiable include forced exit provisions, investor’s approval of selection & dismissal of senior employees, need for investors to countersign bank cheques, management equity ratchet provisions and upfront specification of mechanisms to resolve disputes. Paul et al. (2007) studying the investment process of Scottish business angels term the negotiation phase of angels as “bargaining stage,” that could be very hectic for investors till an agreement is reached. They further note that the various activities that angels engage in at this stage include arriving at a valuation of their equity stake through robust discussions, taking stock of their risk-reward parameters & future funding needs of the venture, allocation of share holding among different stake holders, and so on.



Various studies, however, document that angels negotiate less than VCs do (Freear et al. 1995, Mason and Harrison 1996, van Osnabrugge and Robinson 2000). The deal structure of angels tends to be shorter and more informal than that of VCs (Sohl 1999 early). Venture capital deals include more than four times the number of terms and conditions than angel deals and are more complex in nature (Sohl and Areson- Perkins 2001). Wong (2002) observes that angels, unlike VCs, do not rely upon contractual controls to protect themselves from risks of expropriation by an entrepreneur. The negotiations between a VC and an entrepreneur primarily centre on valuation of a company, composition of the securities sold, founders’ percentage of equity, representations, warranties, covenants, change of control levers subjected to performance milestones, registration rights, conversion and antidilution provisions (Shaheen 1999 cited in Kirilenko 2001). van Osnabrugge and Robinson (2000) mention that a VC negotiates “on and off” for seven weeks on average (median= 4 weeks), which for an angel could last for about a week in a much more relaxed environment. They attribute this to three causes: first, angels apprehend that “in pushing an entrepreneur too much for a better deal,” they would jeopardise their future working relation with entrepreneurs; second, the difficulties associated in evaluating an early stage venture makes an angel’s negotiations a lot informal; and third, angels may be more concerned in releasing early cash to entrepreneurs, whose pecuniary needs may be immediate. The process of negotiation and deal structuring done by the VCs is in many ways similar to the angels, but could be more structured and rigorous.



Negotiations between a VC and an entrepreneur have been commented as incomplete (Black and Gilson 1998, Gompers and Lerner 2001, Kaplan and Stromberg 2003). Sahlman (1990) notes that negotiations could reduce problems of information asymmetry. He notes that the process of financial contracting in venture capital deals focuses on some of the essential issues of allocation of cash, risk and incentives between an investor and entrepreneur. Keeping these objectives in mind, VCs, he further comments, structure their deals so that they could exercise control over a firm, incentivise performing mangers through compensation schemes, design their post investment role and plan their exit. Fried and Hisrich (1994) state that venture capital contracts very much serve as a sorting mechanism by allocating risk of their failure to an entrepreneur, and this discourages entrepreneurs who are not sure about the success of a venture. Contracts help VCs to safeguard their investments from moral hazard problems that may involve shirking, withholding important information and passing much of the risk to a VC by an entrepreneur (Fiet 1995, Reid 1998). Moral hazard problems, notes Prowse (1998), whereby management pursues its own interests at the expense of investors are minimised through adequate deal structuring that helps in aligning interests of the managers and investors. A deal structure that visualises performance incentives for the managers (by considering level of managerial stock ownership, type of equity participation and terms of management employment contracts), and control of the firm by the investor (through board representation, allocation of voting rights and control of access to additional financing) could, according to Prowse, reduce moral hazard problems. The primary purpose of a contract between an entrepreneur and a VC is to align incentives of the former with goals of the latter (Gompers 1997). Manigart et al. (2001) note that the level of mutual trust between an entrepreneur and investor does not influence the number of contractual clauses that an investor would like to include in his contract, but might influence an entrepreneur. They conclude that trust and control play complementary roles in shaping contractual preferences of an investor, and if an entrepreneur is more open to contractual clauses as desired by an investor, he may send strong signals regarding the quality of his venture (minimise adverse selection) and his own ability (minimise moral hazard). Kirilenko (2001) theoretically demonstrates that control in venture capital deals is a continuous variable (in contrast to a binary variable where it is allocated either to a VC or to an entrepreneur at any one point of time), whose allocation is contingent upon unpredictable future scenarios. He then goes on to prove that a VC will allocate more control rights to himself when the degree of adverse selection is more, and apparently due to this reason a VC would like to retain control levers that are disproportionately higher than the size of his equity investments. Kaplan and Stromberg (2003) observe that venture capital contracts allow VCs to separately allocate cash flow rights, board rights, voting rights, liquidation rights and other control rights as these rights are often contingent on observable measures of financial and non-financial performance. They then go on to derive a number of useful axioms. First, if a firm performs poorly, then a VC obtains full control. Second, with improvement in performance an entrepreneur regains most of his control. Third, when a firm performs very well, the VC retains the cash flow rights, but relinquishes most of the control and liquidation rights. Fourth, a VC could minimise potential hold-up problems between him and an entrepreneur by including non-compete and vesting provisions that make it more expensive for an entrepreneur to leave the firm. Bottazzi et al. (2004) examine contractual sophistication of European VC deals and note that nearly 70% of VCs use pure equity as their mode of investment, a little more than 20% use preferred equity, less than 5% use convertible debt and straight debt. They further note that nearly 2/3 rd of the VC deals make use of at least one contingent clause. Kaplan and Stromberg (2004) demonstrate that formulation of VC contracts is dependent upon the prevalence of three types of risks (whose substratum lies in agency risks), and then the nature of the contracts could motivate some of their ex post investment actions. Higher internal risks are associated with more VC control, more contingent compensation for an entrepreneur, and more contingent financing in a given round; higher external risks are associated with more VC control, more contingent compensation for an entrepreneur, increases in VC liquidation rights, tighter staging; execution risks are negatively related to many contractual terms such as contingent compensation and VC liquidation rights, but positively related to founder vesting provisions. Talking about the actions of the VCs, Kaplan and Stromberg observe that management intervention by a VC is related to his controlling power of the board, and his support or advice is related to his equity ownership. According to Weiss (2004), the features of a Venture capital agreement depend on elements that include experience and reputation of an entrepreneur, attractiveness of the portfolio company as an investment opportunity, the stage of a company’s development, negotiating skills of the contracting parties and the overall state of the venture capital market. Parhankangas (2005) note that more experienced VCs prefer to include more control and exit rights in their contracts than their less experienced colleagues; these experienced VCs, he further notes, wish to compromise and solve problems in collaboration with an entrepreneur rather than by seeking legal protection through legal contracts.



The literature review in this section provides a succinct description about the nature of negotiation and deal structuring phase that includes negotiation mechanism, description of term sheets and investment contracts of the angels and VCs. The review focussing on the nature of negotiations, deal terms, and investment agreements of angels as well as VCs succeeds in setting out the state of present knowledge about the phenomena for both the categories of investors. The negotiations of the angels have been reported to be person specific, dependent upon context of investment, stages of a firm, issues of ownership, control, and so on. The VC negotiations, on the other hand, are more conspicuous by a concern with issues of minimisation of adverse selection and moral hazard problems, alignment of incentives between investor and entrepreneur, linking of allocation of various rights and controlling issues with achievement of performance targets, linking of contractual terms with estimated risk parameters, and post investment role of an investor, linking of various contractual terms with contexts of investments, and so on.



4.2 Valuation and ratchet mechanism

According to finance theory, the value of a firm should be equal to the discounted value of its expected future stream of cash flows and the movement of equity price should be guided by the changes in the expected cash flows or the cost of capital of a firm (Weiss 2004). But, such a valuation may not be possible for the typical unquoted companies that the angels are called upon to invest. Mason and Harrison (1996) thus rightfully note the difficulty that angels face in valuing a venture or pricing their stake in it, especially when they are required to commit large sums of money. It is in this regard, they note that, adhockery and rules of thumb principles largely dominate the pricing of their investments, and only a small minority of deals involve complicated calculations. The crux of the matter is that unproven entrepreneurial firms are difficult to value (van Osnabrugge and Robinson 2000). Benzamin and Margulis (2000, p.) state “if any term receives reverential treatment in the business of financing a venture, it is surely valuation.” Benjamin and Margulis also explain that the valuation process is based on rules of thumb that differ for each investor. An angel thus relies upon a subjective mix of different criteria to value an entrepreneurial firm and this is ideally when his gut tells him to proceed ahead with an investment. Before an investor starts valuing a company, he makes himself sure that a venture has the right entrepreneurial talent, there exists an attractive target market for a venture and the business model is adequate (Camp 2002). The usual problems of the valuation process are that an investor tries to negotiate a low pre-money valuation, so that he obtains a greater ownership percentage, and an entrepreneur tries to negotiate a high pre-money valuation so that he relinquishes less of the equity to the investor.



The issues that could mainly influence valuation of a venture include sweat equity, liquidity concerns of an entrepreneur and risk factors of a venture (Benjamin and Margulis 2002). The sweat equity of an entrepreneur refers to the time and labour he has invested in the pre-money valuation of a venture. The problem, according to Benjamin and Margulis, arises when an entrepreneur asks an investor to reckon his past sacrifices that include his lost salary, mental and physical agonies in bringing a venture to the stage of valuation and compensate him for that (the entrepreneur insists for the valuation of his opportunity costs). A degree of risk centres the valuation process. This risk refers to certain aspects. First, an investor’s individual perception of the amount of work already accomplished by an entrepreneur in developing and selling a product or developing the market. Second, his investment in the stage of a venture- if the venture is a mere idea or a concept, the risk is more (in compared to an established product) despite the fact that an entrepreneur is talented and trust worthy. The measure of risk being subjective is measured differently by different investors. The criteria centring this process could revolve around the following factors:

• How much risky is the deal?

• How far along the entrepreneur is in the process of building his venture?

• Has validation through other investors occurred?

• Is there already a market for the company’s products? And etc.



There are no sure-fire ways to the valuation of an early stage venture. The valuation done by the VC is also similar. Sahlman (1990) discusses a standard evaluation technique, wherein the VC first makes an assessment of the projections to be achieved by an investor; second he values the company at a future point of time when he would have to preferably exit or liquidate his investment; third he would, using a suitable discounting rate, find out the present value of the exit valuation; and fourth, he would determine his percentage share holding by dividing the present value with his invested amount. The discounting rate, according to him, which is between 40% and 60%, is often difficult to determine. Plummer (1987) cited in Sahlman (1990) states that the discount rates used by VCs vary by a company’s stage of development. The Venture Capital valuations, according to Weiss (2004), are done on the basis of a company’s past R&D efforts, current level of sales turnover, tangible assets, and the present value of expected future profits. Timmon and Spinelli (2004) state that the four valuation methods of discounted cash flow, earnings multiple, net asset and venture capital method as advocated by the corporate finance literature are not very suitable to value new ventures due to inefficiency of the market in which they operate. van Osnabrugge and Robinson (2000) and Camp (2002) advocate the use of three approaches for the valuation of entrepreneurial companies- market based approach, asset based approach and discounted cash flow approach.



Each of these approaches has unique merits and demerits and could be complicated, the valuation in question being that of a venture whose success is highly speculative. Murray (1994), in this context, discusses the use of stick and carrot system of ratchets (these are performance driven incentive ratchets for the entrepreneur) by a VC to scale up or down his stake. The ratchets enable a venture investor to be oblivious of the exigencies ahead, arrive at a tentative valuation and set the records straight (scale up or down the percentage share holding) after a company achieves certain milestones or misses them. Kelly and Hay (2003) in a UK based study note that over 38% of angel deals included ratchets, and these were used by investors as a basis for deciding their equity split by asking the entrepreneurs to achieve a set of projections or performance targets. van Osnabrugge (1998) observes that angels are less worried about valuation of ventures and their equity stake in it, and more worried about the survival and risks involved in a business.



The review in this section points to the difficulty in valuation of entrepreneurial ventures by angels and VCs, and their consequential dependence upon adhoc and rules of thumb measurements that reckon sweat equity of an entrepreneur and risk factors present in a venture. Nevertheless, the use of various valuation mechanisms, like, market based approach, asset based approach, discounted cash flow approach, venture capital approach as proposed by various scholars and practitioners still hold good in entrepreneurial financing. The use of ratchets by investors to minimise contingency risks and value a venture is also probably unique in situations of entrepreneurial financing.



4.3 Share Holding Pattern

Angel investments are done primarily through ordinary equities (Short and Riding 1989, Norton 1995, Prowse 1998). Some angels, according to Prowse in a US based study, like to opt for convertible preferred equity; and this helps them in two ways- reduces their investment risk and provides strong performance incentives to the company’s management who typically being the holders of common stock have all the residual profit to enjoy. The VC shareholding pattern could be more elaborate.

Sahlman (1990) observes that convertible preferred stocks help VCs to derive some income from their investments if a company is only marginally successful, then helps to incentivise the entrepreneur through proper conversion ratios when the company does well (a ratchet like mechanism) and also to lower his taxable income. According to Berlin (1998), a VC invests usually through convertible stocks and this enables him to receive a fixed payment, retain voting rights and the right to redeem his shares whenever he wills. He therefore, states Berlin, has access to multiple levers of control, could exit a firm whenever he desires and endowed with a right to convert the shares (to ordinary equity) is induced to create value for a company’s share price. The VCs, according to Zider (1998), mostly opt for preferred equity , anti-dilution protection and ratchets. Further, according to him, these deals often include blocking rights or disproportional voting rights over key decisions that include timing of exit by VCs. All these features help VCs to protect their downside risks and keep an option open for additional investment if the company performs up to their expectation. Cumming (2002) observes that VCs in the US mostly invest in convertible securities, whereas European VCs though prefer to invest in ordinary equity, still use a wide variety of securities. Most important, while trying to study the use of different securities by the European VCs, he notes that the type of the entrepreneurial firm (e.g., stage of development, industry type), board seats, specific contingencies, veto rights and other control rights determine the type of investments by them. He concludes that different securities are not functional equivalents in venture capital contracts. Further, convertible securities help in solving conflicts of interest between an entrepreneur and a VC (Bascha and Walz 2001), and in protecting a VC from dilution and expropriation from a third party acquirer in the event of his exit (Berglof 1994). Gilson and Schizer (2002) note that convertible securities help the management of the firms better plan their taxes on their incentivised compensation. According to Gompers and Lerner (2002), VCs demand preferred stock with a number of restrictive covenants and representation in the board of directors; these features help VCs to align their incentives with those of the investors. Cornelli & Yosha (2003) in the context of VC financing demonstrate that convertible securities abate problems of “window dressing” or “short termism” on the part of the entrepreneur through the threat of conversion. Schmidt (2003) argues that one of the most important functions of convertible securities is to allocate cash-flow rights.



The review in this section points out the shareholding pattern of the angels and the VCs. Angel deals are mostly done through ordinary equity. VC deals are on the other hand done through convertible equities and they enable them with control levers and incentivise them properly. .



4.4 Covenants

The angels do not use very many contractual covenants as used by the VCs, but rely more on their gut feeling about the potential success of a venture as well as the actions of its management (Prowse 1998). The existing angel literature does not significantly discuss the use of covenants by the angels. So, the VC literature is exclusively reviewed.



According to Fiet (1991), contractual covenants are called as terms and conditions of the relationships between managers and VCs, and specify the rights and obligations of both managers and VCs throughout their relationships. A distinguishing characteristic of VC contracts is the extensive and sophisticated use of covenants, which is not uncommon in other financing agreements that involve, for example, the disbursal of loans and bonds (Megginson 2004). Megginson lists a number of contractual covenants that include acceptable leverage, dividend pay out ratios, levels and types of business insurance, restrictions on disposition of assets, terms under which additional funding may be provided, walking out of the investor and golden parachute rights for the entrepreneur if he is forced out of the venture. Gompers (1997) and Hellman (1998) cited in Schmidt (2003) argue that the allocation of cash-flow rights could be separated from the allocation of control rights by the use of covenants. Gompers documents that covenants are used to give the venture capitalist the right to control the board of directors, approve major expenditures, liquidate the firm, and even replace the entrepreneur in case of his non-performance by an outside manager. Contractual covenants must be carefully laid out in the investment agreement, otherwise instead of bringing a positive outcome they could prove to be undesirable and costly for the VCs (see Fiet et al. 1997 for a detailed discussion). Barney and Fiet (1994) borrowing perspectives from transaction cost economics and strategic management demonstrate that enforceability of contractual covenants limit managerial and competitive opportunism, and is optimal only when the chances of such occurrences are high. They elaborate that contractual covenants, inter alia, specify limits on capital expenditure, managerial salaries, raising of additional funding, technology non-disclosure agreements, and conditions for forcing a change in managing and liquidating a deal. Covenants, notes Denis (2004), help in redressing problems of information asymmetry and moral hazard. The various covenants, according to him, are staged financing, rights of first refusal, anti-dilution clauses, liquidation rights, board rights, automatic conversions, non-complete clauses, ownership and control rights. Further, covenants, according to him, ensure that the financier controls and actively monitors a company and its management, the entrepreneur is incentivised to add value to the investor’s claims and the financier retains the option to liquidate his investment in case the company goes bust. But, having said this, covenants could deprive a company of the flexibility it needs to respond to unexpected situations (Timmons and Sander 1989). Further, it might also be expensive (see Townsend 1979, Gompers and Lerner 2002) to “negotiate and enforce covenants” in angel deals.



The review in this section thus specifies that angel deals are mostly devoid of covenants, whereas the VC deals are more elaborate with these restrictive parameters. They empower the VCs with several controlling and incentive rights, but the angels mostly rely on their gut feeling and are guided by an element of mutual trust.



Conclusion

The review of literature on the negotiation and deal structuring phase of the angels and VCs reflects practices followed in the private equity market in different parts of the world. The tricks of trade in this market and sophistication in deal making are evolving, and private equity is gaining importance as an investment vehicle in all parts of the world. It is thus imperative that more and more researches are conducted to understand the intricacties of private equity, disseminate the findings to the entrepreneurial community and the policy makers. The latter’s responsibility lies in helping the researchers with databases about their activities; and for the policy makers it is still more important to incorporate the changing needs of the entrepreneurs and researchers as revealed in guidelines that they frame. All these will lead to the creation of a virtuous cycle of entrepreneurs, investors and researchers where everybody stands to gain from the activities of the other.















































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