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.

Part 11/20 - Twenty Questions You Will Be Asked By Venture Capitalists (If You Get That Far)

By Laurence K. Hayward

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

11. When will your company break even in terms of profitability and cash flow?

I remember when I first became financially independent of my parents. The thrill of freedom was quickly followed by the burden of responsibility. Still, my income exceeded expenses, and I no longer required financial support. In accounting terms, I was solvent. Likewise, my parents had one less thing to worry as much about, financially speaking anyway. The concept is not unlike that of a venture capital investment. Once your business is financially independent and solvent, you become less of a liability to a VC. Certainly there may be opportunities to continue investing, but that might be focused on expansion rather than “staying alive.” VCs would like to get their portfolio companies to this point as quickly as possible. Many only invest in companies that have already passed this mark. Profitable businesses are more attractive to potential buyers and the public markets.

In order to estimate when your company will break even, it is important to have the appropriate financial projections. Many entrepreneurs develop income projections, but fail to fully appreciate the application of the balance sheet and cash flow statement. For example, capital expenditures can drain significant cash upfront even though the effect on the income statement as depreciation expense can be minor in a given year (because the expense is spread over a number of years – the depreciable life of the asset). Likewise, accounts receivable cycles and inventory can have a significant impact on cash flow, which fundamentally is the most critical element to survival. If you do not have the appropriate financial experience, seek out a well-trained advisor who can assist you with your financial projections.

A well-developed business plan will include projected income statements, balance sheets and statements of cash flow five years forward. Many entrepreneurs also provide information regarding the assumptions used to generate the financials.

For example, they may provide pricing and volume data in order to demonstrate how and when revenues are recognized. Whether you present this information in the plan, or reserve it for more detailed discussions with investors is up to you.

However, it is critical that you can support the assumptions logically (with hard data), that your calculations (within the given set of assumptions) are accurate, and that the approach used to arrive at the final set of projections is methodical.

Laurence K. Hayward is the Founder and CEO of TheVentureLab. To learn more about him follow the link here