Rule one: don’t throw out a number
There is one trick question investors almost always ask, and guaranteed to make founders uncomfortable: “What are your expectations regarding valuation?”
For most founders, this is the eternal Goldilocks scenario. Throwing out a number that is too high can drive investors away, while an amount that is too low can raise the question, “Why so low? What’s wrong with this company?” and shareholder value on the table.
And when it’s just right, the knee-jerk response from most investors goes something like this: “Let’s see how much I can work this founder down to a better price.”
Founders are clearly at a disadvantage in the valuation game. By design, investors play this game much better than most founders ever will – a VC may make several deals in a quarter, but a founder may only approach markets once every few years.
So instead of throwing out specific numbers that will inevitably be challenged, here’s a solution:
Don’t throw out a number
The more you try to understand your investors’ thoughts on making deals, the better you’ll be at reaching that deal.
The founder’s most confident (and valuable) answer to the infamous valuation question begins with, “We’ll let the market price this round.”
If it is delivered correctly, it means that you accept offers, that you are not desperate and that you are sure that you will make a deal on acceptable terms.
But if that’s all you’re saying, you’re in trouble because it can also be interpreted as “We have no idea” or “We’ll take what we’re given.” After all, you need to give a basic indication of your expectations if you want to actually close a deal.
Jay Levy, co-founder and managing partner of Zelkova Ventures, explains, “When founders speak to VCs, they should provide an indication of their valuation expectations coming into the conversation. It is important to know that everyone is on the same wavelength, as it would be painful and unfortunate for everyone to head over to a term sheet only to realize expectations are misaligned.”
Collect your rating data points
To underpin your market-based valuation approach, you need to start early. Start by pre-pitching the investors for your next round to collect valuation data points and have low stakes conversations to build the assumption that “we’re probably too early for you, but in 12-15 months we’ll most likely be good to suit.” Always ask in these chats how they would approach valuing your business when the time was right (i.e. in your next round, in 12-15 months).