This is part of my ongoing series, “Pitching a VC” – the entire outline is here
Whenever I sit on panels and discuss the topic of fund raising the topic of how to handle the discussion of valuation (e.g. how much you’re worth) always comes up.
I have very fixed views on this topic although I’ve learned through these discussions that not everybody agrees with me. Having sat on both sides of the table on many occasions – I’m pretty sure I’m right about this one ;-) I know that the line of answering below mostly applies to 2009 (e.g. tough fund raising environment) but I think holds more generally.
VC asks the following line of questioning:
Q: What was your last round post-money valuation?
(translation: how expensive was this deal previously? Do I think they’ll want an up-round, down-round, flat-round?)
Q: When did you raise the money?
(translation: if it was raised in the peak of the market and the price was high then I should be looking for a down round. If you raised it 1 year ago, what progress have you made that would justify a flat round or an up round)
Q: What are your expectations on valuation? … or … What price are you raising at now?
(translation: based on my views of whether you’re over valued at the last round or not, please help me figure out whether it’s worth spending any more time with you now. My scarcest resource is my time. If you or your investors have unrealistic expectations on valuation I don’t want to waste my time trying to talk you down on price. I’ll just move one. There’s plenty of other “fairly priced” deals out there. See here for an article in the NYT on this tension.
So what do you do? My advice:
1. Be humble. I prefer the following line, “Listen, we know that it is a tough market out there. We’re realistic about valuations right now. Obviously we want to get the best valuation we can but we understand the current environment and what the normal valuations are at this time.”
(translation: we want a fair price but we’re not going to be difficult. Spend more time with us. Come on, you know you want to!)
2. Don’t name a number. It’s up to a VC to price a deal. He/She knows that. They don’t need you to tell them your asking price – they just need to know that you’re not on another planet. We all had the pre-revenue companies in 2007 trying to get a $40 million pre-money valuation. It took time for those people to realize that the market had changed so we want to be sure you’re not still one of those.
3. Don’t say, “we’ll let the market determine the price.” That’s everybodies’ favorite line.
(translation to us, “we’re going to run a competition and whoever pays the highest price will get the deal.” I know that’s not what you mean, it’s just how it sounds in VC speak.
4. Don’t sound desperate. I know it sounds obvious but you’d be surprised that some people really come across this way at times. I think some people are so beat up and tired of the fund raising process that they already are like dogs with their heads down expecting to be hit. The number one rule of VC is to make it seem like you have other options and these are likely to yield results. You’re looking for understated optimism. Someone else is planning to ask you to the prom.
5. Make it clear that price isn’t the only determinant. My recommended line (and I hope you actually mean it!) is, “We obviously want a fair price but price isn’t the only consideration for us. We want an investor who does A,B,C. Ultimately financial success for us isn’t going to come from an additional 5-10% in this round. It’s going to come from a thoughtful and hard working executive team & board. We’re looking for somebody that can contribute to this.”
Final note: Unfortunately many deals from 2005-2008 were overpriced or have investors no longer wishing to invest. Most teams think the best way to fix all this is by bringing in a new investor. I know that the easiest way to get concessions out of your existing investors is to have a term sheet so I understand the sentiment. But I recommend trying your best to clean up your Cap Table before fund raising. It is hard enough to raise VC in this market with a “clean” deal that is doing reasonably well. The odds are stacked against you if your deal “has hair on it.” Go to the barber and clean it up.