The fundraising process for entrepreneurs can be an incredibly stressful and testing time, particularly when an investor has a good nose for the valuation of a business.
You must always have in mind that potential investors are normally across hundreds of deals at any one time and therefore understand the market place and the price point on said deals.
Imagine if you were buying a car from a showroom. The salesman knows each make and model inside out and how much the car is worth, whilst you’re trying to second guess (if the price isn’t shown). It can be quite intimidating, right?
It’s hard to compare valuations across startups, however, it’s possible to understand what potential investors could be looking to find out in order for them to make an offer to fund your company.
Of course, they always want to have the upper hand, but WGP Global’s handy guide of what could be asked of you during negotiations, turns the tables in your favour.
What was the post money on your last round?
Founders often don’t like sharing confidential information which could potentially hurt them, but there’s no getting away from the fact that new investors will routinely ask for an idea of capital raise to date as well as the post-money valuation on the last round of fundraising.
You should be aware that potential investors will have access to certain databases that will probably arm them with the information they want anyway, however, your responses to their line of pretty straightforward questioning will outline to them the type of people they would potentially be dealing with. Get too defensive and you may find you’ve lost yourself a new source of income.
Be aware that potential investors are almost always looking for the right ‘fit’ with a company, from a big pool of choices. A typical seed/A/B round company may have a desire for certain ownership targets and will almost always try to place their investment in firms with a high conviction, given their limited reserves of capital and time. An investment of £5m with a target of owning 20 percent, would see £15-20m deals in the pre-money range.
Trying to understand where a potential investors ‘norm’ is, is a pre-requisite. This is because often there will be an investment at the early, mid and late stages of development. What is the investor looking for? Price-sensitive deals at the early stage, or moving around more capital at a later stage?
Don’t lose sight of the fact that at every stage, investors will be testing the waters to determine whether the last round valuation was significantly over-priced. This can see people walking away from a deal in preference to trying to drive the valuation down.
The latter could see what’s termed as a ‘down round’ or ‘flat round,’ and that generally causes resentment amongst shareholders because there is too much dilution. Furthermore, potential investors are savvy enough to know that founders who don’t own too much of the company are already thinking about a new project and are looking at exit strategies.
When asking the question about capital raising, it’s simply the investor trying to determine how efficient the company has been to date with regards to funds, because with so many other deals to choose from, he or she isn’t going to partner with those whose egos are easily bruised, or whose companies have raised a good amount but haven’t got much to show for it.
What expectations do you have about valuation?
A potential new investor is bound to ask you about your own expectations on company valuation during the fundraising process.
Ideally, you should give a general range ‘there or thereabouts’ regarding the company, thereby not committing 100 percent one way or the other.
Plenty of startups have floundered because entrepreneurs have either priced their business far too low or so high that any potential investor walks away from the deal.
Therefore, it’s often necessary for the potential investor to name his or her price, particularly given that it’s common practice for them to do so in any event.
If it helps smooth the pathway, perhaps consider flipping the narrative and suggesting that, as they’d already have a sense of company worth, how well they feel the market is pricing rounds of similar company size.
Try and temper any expectations whilst also gauging their responses to the news of how well your company has been performing and what the demands placed on other investors has been.
You may even want to suggest that you’re going to allow the market to dictate what the best price is, and that you know in general terms how investors normally price certain rounds. Showing them that you have a grasp of the situation inspires confidence.
Are your existing investors participating in this round?
This is where things get a little more interesting.
Position yourself as a new investor. Clearly, you’ll be aware that any investors from a previous round of funding will have the knowledge on how well the company is performing, whether the team in place are fit for purpose and other metrics, such as where the company sits in relation to the competition.
You’ll want to understand how much previous investors paid and whether they’ll be adding to their investment this time around. If not, alarm bells will be ringing.
Ideally, when a startup is raising more capital, a conversation needs to be had with those who had previously invested.
Not only will you be able to gauge whether they are supportive of such a decision, but you’ll be properly informed before fielding – perhaps difficult – questions from potential new investors.
Do bear in mind that a potential new investor may be looking for a certain mount of ownership before placing funds with you, and as a result may not be overly happy that their ideal share of the business is diluted by existing investors.
Be forthcoming and confident when answering any concerns. For example, if existing investors are supportive and you can meet the needs of both those and any new investors, say so.
Don’t try to hold anything back, for it will hurt you in the long run.
Being open and honest at this stage demonstrates to a potential new investor that you have a good grasp of the situation, and that you understand – and have a willingness to meet – their ownership targets.
A future, larger round of funding should also be successful on the back of the above, given that those invested will have already seen that you’ll do everything possible to keep all investors happy.
When should you name a valuation expectation?
If you happen to have many investors interested in your business, firstly congratulations and secondly, you might want to name your valuation off the bat. That should help to give you some momentum at least.
Getting a lead investor to bring £15m or so to the table can be problematic, but you may find you’ll get a handful that are prepared to hand over £2m-£3m.
In both cases, it makes sense to name a valuation from the outset as potential investors can see how similar types of businesses are valued.
There’s a certain amount of rationale involved in justifying their outlay which you would play a part in, given that if they’re aware that other potential investors are paying the same price, that’s a positive aspect from the outset.
Given that strategic investors often don’t enjoy naming a price or leading a funding round, getting them to give a definitive yes or no is preferable.
Turning the tables
There’s always the possibility of turning the tables of course – if you’re confident enough to do so.
Don’t skirt around the points you want to make, however. You’re well within your rights to get feedback from potential investors, and to decide whether they are in fact the right fit for you. Fundraising remains a two-way process after all.
Just make sure that none of your own questions are open-ended but invite comment.
If an investor is serious about placing funding with your startup, then he or she is not going to take umbrage at a few pointed questions coming back their way.
Don’t waste your time with companies that don’t have your best interests at heart. If you’re an entrepreneur needing advice, WGP Global are here to help, and we want to hear from you. Please contact us at firstname.lastname@example.org