Part 12/20 - Twenty Questions You Will Be Asked By Venture Capitalists (If You Get That Far)

By Laurence K. Hayward


This is part twelve of a twenty part series on this topic.

12. What is your valuation?

This could be one of the most difficult questions of all. Answer too high and many investors will simply reject the opportunity outright. Why would they do that even if they like the opportunity? They may take it as a sign of inexperience and excessiveness, or they may simply view it as unproductive – that is, it will be too risky and time-intensive to find acceptable terms. Answer too low and you’re giving up more of your business. The common saying in venture capital is that it is better to have a piece of something, than all of nothing. But, that doesn’t provide much help after all, unless you’re down to your final option.

One way to think about valuation objectively is to step outside ‘negotiated thinking’ for a moment and imagine you were trying to set the price of a new product you were preparing to release. How would you determine the price? Most likely you’d study the market demand for the product first and seek information regarding the elasticity of potential buyers. You’d try to get objective and independent feedback of various price points. You’d try to understand the perceived value of the product because ultimately that will likely yield a higher price than some ratio to cost. You’d compare it to other similar product offerings already on the market.

Try to find a trusted source or two to help you with an analysis like this for your business. Also find someone who can help you understand the most appropriate valuation methods based on the characteristics of your business situation. Sound like a lot of work? It is. This is why many believe that raising capital is a full-time job, and find outside advisors to assist with the process.

Don’t forget Economics 101, which tells us that price is ultimately determined by supply and demand. How does this apply? First, don’t “shop” (promote indiscriminately) your deal else you’ll unintentionally make it appear oversupplied and less valuable. Second, don’t stop at the first investor who seems interested. Try to find other (carefully targeted) investors who are interested. While it is rare to encounter a bidding war, having credible investors interested in your company can raise its perceived value. Third, understand the nature of syndicates (multiple VCs investing together in a round), which is how many early-stage deals are done today. The lead investor typically sets the valuation and the other investors in the round follow. Know with whom you need to focus your negotiations.

Information regarding valuation does not belong in the business plan. Rather it is included in a private placement memorandum (PPM) and subscription booklet. If you are seeking funds primarily from VCs, valuation will likely be handled in the form of a term sheet developed by the VC to be negotiated between parties. If you are seeking funds from accredited investors or angels, the valuation will usually be covered in the PPM or subscription agreement.