Every entrepreneur who is raising equity capital is going to spend a lot of time and energy on the valuation question. What is my company worth? How much equity is reasonable for me to sell? How do I ask for a “fair and reasonable price”? A few thoughts he/she should consider are below.
Know your Valuation
First of all, it’s a two-sided marketplace with buyers (venture capitalists) and sellers (founders). As with any other two-sided market, the answer to the question of “what’s it worth” is really, whatever price the seller is willing to live with and the buyer is willing to pay. Therefore, start by understanding it’s all negotiable. If you are a first-time entrepreneur your valuation is likely to be lower than an entrepreneur with multiple successful scale-ups and exits under his/her belt- even for the same technology. Market dynamics including what position the founder/company is in, how many funders are willing to invest, how much free capital is chasing new opportunities, how much “traction“ (topic for another day) the company has achieved, etc. all play a role in determining the context in which buyers and selling are negotiating.
Be Prepared with Data
Secondly, the VC fund has more information to use when negotiating. They see more deal flow, and they know what other companies have raised and at what valuation. They often have access to datasets like Pitchbook or CrunchBase. Too many entrepreneurs are going in blind. It would be like walking into a car dealership, in clear need of a new car and having no information on what cars are selling for! So do your homework. Talk to your advisors, bankers, and accountants to try and find “comps” with companies in your space and at your stage. Find a group that has access to Pitchbook (in the triangle NCBC will do custom searches for a fee). And build your case. It’s like getting those research services with all of the information on what the car dealer has paid for the specific car you are looking at. You still may not negotiate the optimal deal (see market dynamics above and how to bracket below), but you at least will be smarter at negotiations and know exactly what you are giving up.
It Takes Skills to Negotiate Well
Lastly, learn to negotiate well. In business, negotiating skills will serve you well in any situation (contracts, partnerships, staffing, services, etc.). The general rule of thumb is not to be the first to put a number on the table. However, when raising equity, neither side wants to waste time if the deal does not fit the parameters. Many VC’s will ask what the post-money valuation was from your last fundraise. It’s just a quick, easy way for them to know if your opportunity is even in the same range/stage their investment thesis dictates. No need to be coy here. Answer the question clearly and succinctly, and then highlight the significant achievements you have made since that raise so you are clearly communicating that you (and your previous investors) expect an appropriate increase in valuation.
You can also do a “bracketing” tactic. That is saying “we expect to raise $X somewhere in the $Y-$Z valuation range”. By doing this you are again letting them know that you are open to negotiating, but only within a specified range. Mark Suster has written some great posts on this topic in his “both sides of the table” blog posts (if you don’t follow Mark, do so now!)
The above is a short and by no means complete overview of how to handle the valuation question. At the CED Accelerate series we will be covering this topic in greater detail and give you the chance to ask your questions. Sign up now