First rule: Don’t throw a number
There is one trick question that is almost always asked by investors, and guaranteed to make founders uneasy: “What are your expectations surrounding the valuation?”
For most founders, this is the perennial Goldilocks scenario. Throwing in a number that’s too high can drive investors away, while a value that’s too low can prompt the question, “Why so low? What’s wrong with this business?” and leave the shareholder value in the table.
And if it’s right, the answer of most investors is like this: “Let’s see how much I can build this up to a better price.”
Builders have a distinct disadvantage in the valuation game. By design, investors play this game better than most founders – a VC can make several deals in a quarter, but a founder can only approach the markets once. every two years.
So, instead of throwing out certain numbers that will inevitably be challenged, here’s the solution:
Don’t throw out a number
The more you seek to understand the minds of your investors when making the deal, the better you will be at getting that deal.
The most confident (and valuable) promoter’s answer to the bad valuation question begins with: “We allow the market price at this stage.”
When delivered correctly, it means you’re accepting offers, you’re not desperate and you’re confident you’ll close a deal on acceptable terms.
But if that’s all you say, you’re in trouble because it can also be translated as “We don’t have a clue” or “We’ll take what we give us.” Then, you need to provide a baseline indication of your expectations if you want to close a deal.
Jay Levy, co-founder and managing partner of Zelkova Ventures, explains, “When talking to VCs, founders should give some indication of their expected valuation coming into the conversation. It’s important to know that everyone is on the same page, because it is painful and unpleasant for everyone to develop a term sheet only to find out that the expectations are not correct.
Gather your valuation data points
To validate your market-based valuation method, you need to start early. Start by pre-pitching investors for your next round to collect valuation data points and have low-stakes conversations to build on the assumption that “maybe we’re too early for you, but in 12-15 months, it’s likely to be a good fit.” In these chats, always ask how they approach valuing your company when the time comes (ie, in your next round, 12-15 months from now).