Rule one: Don’t throw a number
Only one The trick question investors almost always ask, and it’s sure to make founders uncomfortable: “What do you expect around valuation?”
For most founders, that’s the perennial Goldilocks scenario. Giving a number too high can drive investors away, while giving a number too low can cause the question, “Why so low? What’s wrong with this business?” and leave shareholder value on the table.
And if that were true, most investors would react in a hurry like this: “Let’s see how much I can give this founder to get a better price.”
Founders are at a distinct disadvantage in the pricing game. By design, investors play this game much better than most founders ever do – a VC can do many deals in a quarter, but a founder can only reach the market. school every few years.
So, instead of having to give specific numbers that will inevitably be challenged, here’s a solution:
Don’t throw out a number
The more you try to understand the investor’s mindset about making a trade, the better you will get at that trade.
The founder’s most confident (and valuable) answer to a well-known valuation question begins with, “We’re pricing in this round.”
When delivered correctly it means you are taking offers, you are not desperate and you are confident that you will close a deal on acceptable terms.
But if that’s all you say, then you’re in trouble because it can also be interpreted as “We don’t have a clue” or “We’ll take what we’re given.” After all, you need to give a basic indication of your expectations if you really want to close a deal.
Jay Levy, co-founder and managing partner of Zelkova Ventures, explains: “When talking to VCs, founders should give some indication of their valuation expectations during the conversation. It’s important to know that everyone is on the same page, because it would be painful and regrettable if people came to a term sheet only to realize that expectations had been skewed.”
Collect your pricing data points
To demonstrate your market-based pricing method, you must start early. Start by pre-introducing your next round of investors to collect pricing data points and have low-risk conversations to build assumptions that “we might be too early for that.” with you, but in 12-15 months we will most likely be a great fit. During these conversations, always ask how they might approach your company valuation when the time is right (i.e. within your next round, 12-15 months from now).