ATTRACTION OF THE BEST OFFER
This guide describes all the steps, processes, and scope of Negotiating.
1. Secure term sheets
1.1. What Is a Term Sheet?
A term sheet is a nonbinding agreement that shows the basic terms and conditions of an investment. The term sheet serves as a template and basis for more detailed, legally binding documents. Once the parties involved reach an agreement on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is drawn up.
* A term sheet is a nonbinding agreement outlining the basic terms and conditions under which an investment will be made.
* Term sheets are most often associated with startups. Entrepreneurs find that this document is crucial to attracting investors, such as venture capitalists (VC) with capital to fund enterprises.
* The company valuation, investment amount, percentage stake, voting rights, liquidation preference, anti-dilutive provisions, and investor commitment are some items that should be spelled out in the term sheet.
1.2. Understanding Term Sheets
The term sheet should cover the significant aspects of a deal without detailing every minor contingency covered by a binding contract. The term sheet essentially lays the groundwork for ensuring that the parties involved in a business transaction agree on most major aspects. The term sheet reduces the likelihood of a misunderstanding or unnecessary dispute. Additionally, the term sheet ensures that expensive legal charges involved in drawing up a binding agreement or contract are not incurred prematurely.
All term sheets contain information on the assets, initial purchase price including any contingencies that may affect the price, a timeframe for a response, and other salient information.
Term sheets are most often associated with startups. Entrepreneurs find this document crucial for investors, often venture capitalists (VC), who may offer capital to fund startups. Below are some conditions that a startup term sheet defines:
It is nonbinding. Neither the entrepreneur nor the VC is legally obligated to abide by whatever is outlined on the term sheet.
Company valuations, investment amounts, the percentage of stakes, and anti-dilutive provisions should be spelled out clearly.
Voting rights. Startups seeking funding are usually at the mercy of VCs who want to maximize their investment return. This can result in the investor asking for and obtaining a disproportionate influence on the company's direction.
Liquidation preference. The term sheet should state how the proceeds of a sale will be distributed between the entrepreneur and the investors.
Investor commitment. The term sheet should state how long the investor is required to remain vested.
A term sheet used as part of a merger or attempted acquisition would typically contain information regarding the initial purchase price offer, the preferred payment method, and the assets included in the deal. The term sheet may also contain information regarding what, if anything, is excluded from the deal or any items that may be considered requirements by one or both parties.
1.3. Similar Documents to Term Sheets
A term sheet may seem similar to a letter of intent (LOI) when the action is predominately one-sided, as in acquisitions, or a working document to serve as a jumping-off point for more intensive negotiations. The main difference between an LOI and a term sheet is stylistic; the former is written as a formal letter while the latter is composed of bullet points outlining the terms.
Although term sheets are distinct from LOI and memorandums of understanding (MOU), the three documents are often referred to interchangeably because they accomplish similar goals and contain similar information.
2. Line item negotiation
2.1. Negotiating the Line Item Price Breakdown
Here’s a quick tip on negotiating price that you will find invaluable when someone asks you for a breakdown of your costs:
Make sure that the total cost, when you add up each item, is MORE than what you are bidding.
Why? The sum of the parts is more than the whole. Have you ever taken your car in to replace an automatic window? It can cost over $400 and it is just a small part of your car. If you bought a car part by part, a $20,000 Toyota could cost you $50,000. But by buying it as a whole, your cost is significantly less.
When a prospect asks for a price breakdown, they want to see how you came up with your final number so they can negotiate your price down. They’ll say things like “Well, we don’t really need this piece so how about trimming that out of your proposal” or “I didn’t realize this component costs so much… let’s take that out.” If you are bidding time and materials, they might say “Whoa! It’s going to take HOW long for this subtask?!? You either have to do it faster or reduce your rate.”
If you add up each line item price and it equals the cost of your bid, it’s very easy for them to tell you what to trim off. That could include profit that you tried to bury in some of your high margin line items.
So, if you make each line item a little bit more expensive so that your total works out to be 20% higher (or more) than the actual fixed price that you are bidding, you can include a line item labeled “Discount” to subtract the difference from the sum of the parts and your actual bid.
This gives you leverage to reduce your discount if they cut out a line item. You can then say “Well, we can take that out, but that will reduce the discount we are able to give you since that is based on the project as a whole based on our initial proposal.”
3. Preferred Equity Financing Term Sheets
As a founder of a startup, receiving your first venture capital term sheet can be one of the most exciting times in the early life of your company. Knowing that potential investors believe in your team and your company enough to want to get involved is a rewarding feeling in and of itself. However, knowing what specific terms and provisions to look for in a term sheet can help you address deal breakers early and get the best deal for your company.
Typically a venture capital financing will take one of two forms: convertible debt or preferred equity. A convertible debt round will typically involve promissory notes issued by the company, that are expected to convert into preferred equity upon the occurrence of certain specified events (usually a good sized equity financing). We will discuss the nuances of convertible debt term sheets in a later post. However, it makes sense to introduce a number of these concepts in the context of a preferred equity financing.
Preferred equity, or preferred stock as the lawyers will usually describe it, is equity in a company that is issued to investors in exchange for capital, with certain preferences and rights vis-à-vis the company’s common stock, usually in terms of priority on return of capital and mandatory upside at a sale of the company. These preferences are designed to reward the risk that investors are taking by investing in the company, by offering special voting rights and preferential treatment for the preferred stockholders in certain situations such as public offerings, acquisitions or liquidations. Preferred equity financing rounds come in different flavors and go by different names to reflect the expectations that come with each type of round. For instance, a “Series Seed” round is still preferred stock, but doesn’t come loaded with the same investor preferences as a Series A round. This post will focus on what you would expect to see in a typical Series A term sheet.
3.1. Where does the term sheet come into play in all of this?
The term sheet is typically the first document that the startup will sign with an investor. The term sheet will outline the major details of the potential investment, which will eventually be addressed in much greater detail by the final transaction documents. Typically term sheets are not binding, except for a small subset of the provisions governing confidentiality, exclusivity and the investors’ transaction expenses (which the company usually pays). The goal of the term sheet is to give the parties an outline of the key points of the investment, and allow the parties to reach agreement on those key overarching items before fleshing out all of the details of the transaction.
3.2. So what are those key overarching items that a company can expect to see when the first term sheet comes across the table?
Price. The first term any founder will examine, and typically the first section of any term sheet, is price. Typically the price is laid out on a term sheet in terms of a pre-money and post-money valuation of the company. Simply put, the pre-money valuation is what the investor is saying the company is worth today, prior to investment, and the post-money valuation is that pre-money valuation plus the anticipated investment amount. The investor’s percentage ownership of the company will then equal the investment amount over the agreed upon post-money valuation. This post-money valuation is calculated on a fully-diluted basis, which means that any shares reserved under a company option pool will be included in the valuation (including unallocated options). As a result, the price term in a term sheet will typically include language that specifies the investor’s percentage ownership following the financing, including shares reserved for an employee option pool equaling a certain percentage of the company’s equity on a fully diluted basis (the option pool percentage typically falls somewhere around 20%).
3.3. Liquidation Preference
Liquidation preference refers to how the proceeds of a liquidity event (a sale of the company, but not an IPO – that is dealt with via the convertibility of the preferred stock into common, and the anti-dilution provisions that protect the preferred before that conversion) are allocated amongst a company’s investors. Typically liquidation preference is stated in terms of a multiple of the per-share original investment price (i.e. 1x, 2x, etc.). This means that in the event of any liquidation or winding up of the company, the preferred stockholders will be entitled to receive their investment back, plus the agreed upon multiple of their per-share investment price before any amount is paid out to the holders of common stock. Once the preferred payout is satisfied, the preferred stockholders will either split the rest of the proceeds on a pro rata basis with the common stockholders (if the preferred stock is “participating preferred”), or the rest of the proceeds will be split pro rata only among the common stockholders (if the preferred stock is not “participating preferred”). These rights will be laid out in the company’s certificate (or articles) of incorporation that is filed as part of closing the deal.
3.4. Protective Provisions
Protective provisions are essentially “veto” rights held by the preferred stockholders over certain corporate actions. Typically, protective provisions will require a separate vote of only the preferred stockholders in order to approve certain actions, including, but not limited to:
Altering or changing the rights, preferences or privileges of the preferred stockholders;
Increasing or decreasing the authorized number of shares of company stock;
Creating any new class or series of preferred stock having rights, privileges or preferences that are senior to the existing series of preferred stock;
The repurchase by the company of any of its common stock;
Any action resulting in a merger, reorganization, sale of control, or sale of all or substantially all of the company’s assets;
Waiving or amending any provision of the company’s charter or bylaws;
Incurring a substantial amount of debt;
Modifying the size of the company’s Board of Directors; and
Executive hiring/termination and compensation.
The top 3 bullets above are fundamental to maintaining the relative benefits of the preferred stock, while the others are somewhat more focused on the conduct of the business itself. Including these provisions in a term sheet give an investor comfort in knowing that it will have a say in many of the big strategic decisions made by the company, and will thus be able to “protect its investment” in a number of circumstances.
Preferred stock will always be convertible into common stock. This is primarily intended to allow the preferred investors to sell in connection with an IPO, but also allows the investor to convert its preferred stock into common in a liquidation situation where the pro rata distribution to the common would result in a higher payout than under the liquidation preference held by the preferred. For instance, in the scenario described in the “Liquidation Preference” section above, if the preferred stock had a 2x liquidation preference but was non-participating preferred (meaning, that when they receive their 2x, they don’t get any more), if the price paid for the company is high enough that it would be advantageous to convert from preferred to common, giving up their preference but also side-stepping the cap, the preferred stockholders would elect to convert to common. There will also always be an “automatic conversion” provision that provides for automatic conversion from preferred to common in the event of an IPO of sufficient size and at a multiple of the original per share price, allowing the preferred investors to participate in the IPO of the company’s common stock.
Anti-dilution provisions protect (to an extent) the preferred holders from later sales of stock by the company at a lower price per share than the amount they paid. Mechanically, this protection comes in the form of an increase in the conversion ratio at which that class of preferred converts to common stock. Initially, preferred stock is convertible on 1:1 basis into common stock via a simple equation in the certificate of incorporation: initial purchase price divided by conversion price (which is, initially, the same as the purchase price). If the company sells shares of common stock (or securities convertible into common stock, such as Series B, or warrants, etc.) at a lower price, the conversion price of the affected class is lowered such that the preferred holder would get more shares of common if they convert.
Anti-dilution comes in levels of severity, including the fairly rare “full ratchet” on the one end (which re-sets the conversion price down to the amount of that lower priced later issuance) and weighted average (both broad and narrow) on the other (which takes a view of the impact of the new shares and new issue price in light of the overall outstanding shares of the company). Some version of broad based weighted average anti-dilution is most common, and the key items to watch out for is the list of types of issuances that would not cause a readjustment of the conversion price, such as board-approved option plans.
3.7. Board of Directors
In addition to the economic details of a preferred equity financing, potential investors are also greatly concerned with the degree of control they will have over the company following their investment. The protective provisions discussed above are one way to achieve this control. Another is by occupying a seat on the company’s board of directors following the transaction. In a typical early stage preferred equity financing, the investor will request the ability to select a subset of the company’s board of directors. For the investor, this not only provides them with a degree of control over the company, but also gives the company the benefit of having an experienced director on the board, who understands the nuances and challenges of creating a successful business. The presence of a board seat provision in a term sheet frequently relates to how much equity the investor(s) are receiving in the transaction – obviously the more equity the investor(s) get in the deal, the more likely it is that they will request one or multiple board seats to adequately represent their interests. There is a great deal of flexibility in how this provision can be structured, but prospective investors will often seek board participation in some capacity, so this becomes a very common provision in preferred equity term sheets.
4. Insurance term negotiation
Although it may seem daunting as an independent pediatrician to take on an insurance company that has not provided fair payment for your services, it doesn’t have to be intimidating or time-consuming. Done in the appropriate way, from a position of power and confidence, the process of negotiation can yield results. Here are eight steps to get started.
4.1. Step 1: Determine which insurance company lags the most in terms of compensation
Figuring out which companies are not meeting your practice’s needs is an important first step, says Chip Hart, Director of PCC’s Pediatric Solutions consulting group. It’s critical to look at the correct metrics. “Don’t pay attention to what they’re paying you for individual procedures,” he says. “Look at the entire revenue for a cohort of patients.” Practices often get caught up in the “shell game” many insurance companies play. For example, you may be able to negotiate a five percent increase in well-visit payments, but then the payer drops immunization payments by $1, resulting in a net decrease for your practice. Instead, begin by sorting payers by average revenue per visit, for all visits. Use this number to decide which company to target for negotiations and avoid getting caught in the shell game trap.
4.2. Step 2: Know your data, know your contract
In the hustle and bustle of patient care and practice management, it’s easy to lose sight of key business documents. Find your insurance contracts and become familiar with them. Are negotiations only allowed during a certain set time period? Any other clauses or stipulations related to payment changes? Going into talks armed with these key details puts you in a position of power.
Have a solid working knowledge of where your practice excels and be able to cite the numbers. Excel at asthma management? Are your HPV vaccination rates above average? Bring this information to the negotiations. This shows that you’ve done your homework and you know exactly why your patients are loyal to your practice.
4.3. Step 3: Make the phone call and ask
You’ve done your homework: You know which company to target based on average revenue across all visits. You know the ins and outs of your contract, and the data supporting your practice’s value. Now it’s time to make the call. The first step is a simple one: Call your representative and ask what you can do to get a better agreement. “You want to do the easy thing first,” says Hart. Sometimes, companies have simple methods to increase payments, like joining a quality program that requires tracking and submitting data for a particular set of conditions. Sometimes, this additional step is well worth the time and effort and meets your financial needs.
4.4. Step 4: Draw your line in the sand; be prepared to take action
Hart points to the popular parenting “how-to” book, 1-2-3 Magic, as a good example for pediatricians entering negotiations with an insurance company. In the book, parents are urged to follow through on an action they promise if a child continues a disruptive behavior. If parents fail to do what they promise to do, the child quickly learns that the consequence will never materialize, and the words lose their meaning.
Take that mindset into negotiations. Gear up and find the insurance company that isn’t paying you properly. Says Hart, “Look them in the eyes and say to them, ‘If you don’t stop becoming my least good payer, I’m going to drop you.’ If they don’t step up, then you drop them. This may sound like a scary proposition, but following through on the threat is key. Be prepared to take action. Your practice will survive because you’ve done your homework, you’ve targeted the right company, and you know your worth. Also, you have an army of loyal families on your side.”
4.5. Step 5: Mobilize your patients
“Your patients are your best asset, by far,” says Hart. He suggests mobilizing them on your behalf. First step: Print out letters to parents of all of the patients who are on the plan you’ve dropped (see a sample letter on Chip’s Blog). Explain that you’ve negotiated with the company in good faith, but that you’ve come to the conclusion that they are not interested in fairly paying for child health. Cite specific relevant examples, like non-existent compensation for depression screening, or vaccination payments that aren’t sustainable. Say to parents that you simply can’t continue to accept this insurance and provide the quality of care that they’ve come to expect from your practice. Give them the time frame within which the insurance plan will be dropped, and let them know which plans you do take. Include contact information for the membership management representative for the company, as well as the name and email address for the company CEO. Link to the company’s financial information, so families can see how profits stack up against the reality for pediatricians in their community.
You must also make clear that the relationship you value the most is between you and your patient families and you will continue to see them, regardless of their insurance coverage. Parents need to learn that it’s the insurance company that has inserted itself into your relationship.
4.6. Step 6: Strategically deploy letters to patient families
You have the letter in hand that makes the case to families that fair payment is necessary for your practice to continue to be a good steward of their children’s health. Be thoughtful and strategic about how you deploy those letters. “When you have that letter, don’t send the letters all at once,” says Hart. Instead, send them out in batches - 50 on Monday, 50 on Tuesday, 50 on Wednesday, and so on as you work through all of the families on the plan. That direct feedback from paying customers – some of whom may be ready to drop their plan to stay with the pediatrician they’ve trusted for years - often makes the insurance company stop and take notice (See some examples of success stories on Chip’s Blog). Hart stresses that you don’t need to be a large practice to make this work. Just one family may pay tens of thousands of dollars in premiums annually. If you are a two-doctor practice asking for a net annual payment increase of $20,000, that may cost the insurance company less than the premiums they stand to lose by even two or three families dropping them.
You should also prepare another, shorter stack of letters – one for each of the H/R departments of the employers who are contracted with the insurance company in question. You will want to point out that the insurance company they have contracted with doesn’t provide the coverage they probably expect. Cite the number of their families who are going to lose their medical homes and quality pediatric coverage. Often, a concerned call from a large local employer is all it takes to get an insurance company to come to the table.
4.7. Step 7: Fill the income gap
The day you start sending the letter to patients, Hart suggests recalling patients from your remaining payers who are overdue for clinical services. For example, in most pediatric practices, half of teenagers are behind on their well visits. Get in touch with those families and make sure those patients come in to catch up on their care. Not only are you providing a valuable service, you’re filling the short-term gap in your schedule. And since you’ve done your homework and dropped the lowest-paying insurance company, you don’t need to bring in as many patients from the remaining companies to fill the gap. For example, if the company you’ve dropped paid you 30 percent less than the remaining payers, on average, you need only to recover 70 percent of the visits. What’s more, if you gave families adequate notice in the letter you sent, some will take the opportunity to switch to an insurance provider on your accepted list. You keep these patients, and the insurance company you dropped stands to lose significant revenue. You will actually find yourself generating more revenue with fewer visits.
4.8. Step 8: Be prepared to re-negotiate with the provider you dropped
You’ve crunched the right numbers and taken appropriate action with the insurance company providing the lowest average payment across all visits. You’ve also mobilized patients on your behalf. This sets the stage for a re-negotiation in the months and years to come.
As other pediatricians in the area begin to feel the financial strain from the low-paying insurance company, they may also drop the provider. Then, as the company begins to have trouble finding pediatric practices to sign on, be prepared for them to come back to you to re-negotiate a contract. You can enter the negotiations from sound financial footing; you’ve filled the income gap by reaching out to existing patients, and you know that the company needs you more than you need them.
In the end, don’t be intimidated by taking on a low-paying insurance company. Know your bottom line, know that your patients are your strongest asset, and stand firm. Enter into negotiations with confidence, and make sure you’re fairly compensated for the important services you provide to your patients.