Rule one: Don’t throw away numbers
There is one a trick question that investors almost always ask, and it’s guaranteed to make founders uncomfortable: “What are your expectations for valuation?”
For many founders, this is the perennial Goldilocks scenario. Throwing out numbers that are too high may turn off investors, while numbers that are too low may prompt the question, “Why so low? What is wrong with this business?” and leaving shareholder value on the table.
And if it’s right, most of the investor’s immediate reaction is like this: “Let’s see how much I can help this founder to a better price.”
Founders are at a clear disadvantage in the valuation game. By design, investors play this game a lot better than most founders ever do – VCs might do several deals in a quarter, but founders might approach the market only once every few years.
So, instead of having to throw out certain numbers that will surely be challenged, here’s the solution:
Don’t waste numbers
The more you work to understand your investor’s thinking about making a deal, the better off you’ll be at getting the deal done.
The founder’s most confident (and valuable) answer to the famous valuation question begins with: “We allow the market price this round.”
When delivered correctly, it implies that you accept the offer, that you are not desperate and that you are confident that you will close the deal on acceptable terms.
But if that’s all you’re saying, you’re in trouble because it can also be interpreted as “We don’t have a clue” or “We’ll take what we’re given.” After all, you need to provide a baseline indication of your expectations if you really want to close the deal.
Jay Levy, co-founder and managing partner of Zelkova Ventures, explains, “When talking to VCs, founders should give some indication of their valuation expectations coming into the conversation. It’s important to know that everyone is on the same page, because it will be painful and unfortunate for everyone to progress to the term sheet only to realize that expectations are not aligned.”
Collect your assessment data points
To validate your market-based valuation approach, you need to start early. Start by pitching investors for your next round to gather valuation data points and have low-risk conversations to build on the assumption that “we may be too early for you, but in 12-15 months, we’ll likely be a great fit.” In this chat, always ask how they can evaluate your company when the time is right (ie, in your next round, 12-15 months from now).
