Ask a Startup Lawyer: Understanding Your BATNA (Best Alternative to a Negotiated Agreement)

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So, you’re ready to negotiate with your VC, and you know this will be a zero-sum game. Every decision is a shift of risk, reward or control. You’ll need to be prepared to compromise on some things, but how do you decide what and when to give or hold firm? You should start by consulting with the experienced advisors in your corner, such as a quality founder-focused startup attorney, but that is only the first step. Enter the BATNA.

What is a BATNA and why is it important?

The term BATNA refers to your “Best Alternative to a Negotiated Agreement.” As an example, say you’re negotiating with MoneyCo Funding Group. If negotiations break down, you must have a plan in place in the event that you or MoneyCo walk away.

Your negotiating position is fundamentally dependent on your willingness to walk away. If you are presented with a set of terms and you are not willing to walk away (or be walked away from), then you have limited leverage. Yes, you can fake a willingness to walk away, but if that is tested, your position will be transparent, and this could negatively impact your long-term reputation.

Your BATNA is your backup option. It’s a plan detailing how your company will survive without any funding or support from the entity with which you are negotiating. This will change depending on the terms provided by the other party.

How to use your BATNA in negotiations

Your BATNA establishes your exit. But, it also dictates whether or not you should walk away from a negotiation.

If you are presented with a set of terms from MoneyCo (let’s call it term sheet X) better than your BATNA, you must decide how much you’re willing to push to improve term sheet X if you can’t afford to lose the initial offering.

Carefully consider how hard you can reasonably push MoneyCo to improve term sheet X before they withdraw their offer. This will depend on your knowledge of MoneyCo’s past negotiations, their previous investments, your gut sense of the individuals involved, their level of interest in your company, and the strength of your BATNA.

Building your BATNA

To create an effective BATNA, you must understand how it compares to as many potential scenarios as possible. Establish a set of assumptions based on what is going on in the market and what you learn from your legal and financial advisors. A good advisory team will have great market awareness.

For example, let’s assume the following:

Without funding term sheet X from MoneyCo, the expected value of your startup in 5 years will be $20 million.
With funding on term sheet X from MoneyCo, the expected value of your startup in 5 years will be $40 million.

With these assumptions in mind, does the comparative startup value mean that your BATNA is worse than term sheet X? Not necessarily. Remember, you need to compare apples to apples.

Let’s say that without accepting MoneyCo’s funding, you would own 80% of your company. This would place the expected value to you of the non-funding scenario at 80% of $20 million, which is $16 million.

Let’s say that a $40 million valuation on term sheet X with funding from MoneyCo requires a series of dilutive events wherein you would only own 30% of your company. This would place the expected value to you of accepting funding at 30% of $40 million, which is $12 million.

In this scenario, your BATNA represents $16 million, while accepting term sheet X leads to an expected $12 million. This would make term sheet X not worth accepting. This is an oversimplification, but this is the framework from which you should consider a set of funding terms.

Improving your BATNA

Establishing and understanding your BATNA is important, but equally important is improving your BATNA. The stronger your BATNA, the stronger your negotiating position because, among other things, it gives you the freedom to walk away. Let’s explore some ways you can improve your BATNA.

Raise the Stakes

The most straightforward way to improve a BATNA is to have competing term sheets from different investors. Suppose that in addition to being offered term sheet X from MoneyCo, you are also offered term sheet Y from InvestorFund. If Y is at least as good for you as X, then you have the leverage to push on MoneyCo. In a worst-case scenario, if MoneyCo won’t budge, you can accept Y from InvestorFund.

Relatedly, if MoneyCo knows it is competing with InvestorFund, it may sweeten its terms to get you to accept their investment. They know that your BATNA is high enough that you don’t need to accept their terms.

Plan Ahead

Another way to increase your BATNA is not to delay funding until you are desperate.

Only form the BATNA from a position of strength. You should create your BATNA as early as you possibly can, and regularly update it based on your current situation.

Decide if you need to shoot for the moon, especially in terms of fundraising. If you think $20 million would be put to use and grow your company substantially, it’s conceivable you’ll find investors willing to invest in that range. But the terms might be terrible.

Alternatively, if you aren’t in the greatest position to raise a lot of money, what can you do with a small amount to get yourself in a better position to be in a better position? If you can grow your company enough with a small investment to ultimately be appealing enough for a larger investment, that initial small investment is a great way to improve your BATNA down the road.

In summary, build your BATNA as early in your company’s formation as possible. Continually update it and consider all your options, as well as market trends. Before going into any negotiation, make sure your BATNA is as strong as possible, and consult with your advisors. Approach all negotiations understanding how hard you are willing to push the other party based on how your BATNA compares to what they are offering. Work to strengthen your BATNA by seeking other investors, and planning for as many scenarios as you can.

The information contained in this article is provided for informational purposes only, and should not be construed as legal advice on any subject matter. You should not act or refrain from acting based on any content included in this article without seeking legal or other professional advice.

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