Experienced venture capital investors have a good idea of which industries are in fashion, and of the risk/reward profile for the particular industry and stage of the deal. They will also have a good idea of what price the deal may bring from another VC. Generally, it’s best to find an investor who will pay a fair price (not necessarily the highest) and who brings other added value to the investment, including a workable, if not close, relationship with the entrepreneur.
The following approach has worked well for many aspiring fundraisers:
• Bring your deal along to the highest stage possible on your own prior to seeking venture capital. This will help maximize your price.
• Discuss possible valuations of your deal with your attorney, accountant, investment banker, and any friendly venture capitalists prior to establishing the price.
• Select a valuation that is reasonable in light of market realities, a bit on the higher side perhaps, so there is room to negotiate. Not so high, though, that the venture capitalist will feel that working with you is a waste of time.
• Try the valuation on several VCs, including at least one who would be a good prospect as a lead investor.
• If the valuation fails to pass “the snicker test” with several venture capitalists, revise the valuation downward.
• Remember that most VC-funded ventures require more than one round of equity infusion prior to positive cash flow or exit. Don’t sell so much of the company that there is none left for the team.
If you sell one-third of your company for $1 million, the valuation or value of your company, at least on paper, is set at $3 million. Remember, the higher the perceived quality, the more likely the higher the price.
Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund