High impact entrepreneurs looking for venture capital or angel financing often wonder whether their business plan and pitch should include a valuation for the deal; i.e. whether they should tell prospective investors right up front how much of the company investors will get for how much capital. I suppose that as we generally live in a world where most ordinary goods and services are clearly marked with prices this instinct is understandable. It’s also wrong. Entrepreneurs should push back the valuation discussion as long as possible. Why? Because valuation is best discussed after a potential investor has decided that she likes the deal. Definitely include the ask in the plan and presentation – the amount of capital sought – but don’t include the price.
If the principle is simple – and I hope pretty obvious – the implementation can at times be problematic, particularly for less experienced entrepreneurs and investors. As a venture investor myself, I recall times where I wanted to get a feel for valuation before investing any time investigating a deal – usually because the entrepreneur was new to the venture capital game. Many such entrepreneurs have highly inflated ideas of how much their technology is worth – ideas so far beyond what a credible investor would pay as to make any significant investment in learning about a new deal a waste of time.
So, as a practical matter, what should an entrepreneur say when a potential investor, early on in the discussion, asks what valuation the entrepreneur is seeking? The answer: punt. Try to find a way to show the investor that you are realistic about valuation without getting specific about the number. If you have done your homework, you should have some idea about what valuations your kind of deal is getting in the current market. The vast majority of the time – at least for early stage deals outside the major venture centers – that number is going to be somewhere in the seven figures range. So go ahead and say something like “we are familiar with market trends and see our deal somewhere in the seven figures area on a pre-money basis.” This should satisfy most experienced investors as an indication that you are not a starry-eyed newbie with unrealistic grandiose delusions on valuation.
If the “we know the market and we know we will be getting a pre-money somewhere in the seven figures range” doesn’t do the trick, here are two possible follow ups. First, add something like “well, the exact valuation will of course depend on how the deal is structured and perhaps even more important what the investor brings to the table in terms of value add.” This is a good approach as it is true (you probably would give someone like Kleiner Perkins a better deal than, say, Hole-in-the-Wall Ventures) and reminds the investor that they should be thinking about selling themselves, too. Second, if a prospective investor just won’t be put off, and you really do want to get a discussion going, you might offer something like “well, we figure that in the current market, and depending on the capital and value add provided by the investor group, we will end up somewhere north of $X million pre and probably south of $Y million pre.” The critical point is to provide only enough information to establish that your expectations are reasonable.
A final note: the ideas in this piece are aimed at entrepreneurs targeting venture capitalists and sophisticated angels. A broader offering – and any offering based on a private placement memorandum (“PPM”) – should (must in the case of a PPM) include at least an implied valuation. But always keep in mind one simple principle: the valuation discussion is always an easier one for the entrepreneur to “win” if it is postponed until after the prospective investor has fallen in love (or at least “like”) with the entrepreneur and deal.