And the damage from Shark Tank goes on…
A few years ago a CEO of a pre-revenue startup reached out to me for guidance. The company was preparing to raise money.
The CEO said to me during the initial consultation, “We’ve had a 409A valuation done on the company, and the valuation indicates the company is worth $20M.
“We’re trying to raise $2M, so I’m going to say that we will give investors 10% of the company. Sounds good, right?”
“No it doesn’t,” I said.
Experienced investors don’t care what you value your company at.
Before I could continue, the CEO said, “Why not? We have this 409A valuation. They have to accept it.”
“Let me explain further,” I said. “The market determines the valuation for your company, not you. And the market in this case is your potential investors.
“Early stage valuations are very mechanical in nature. Investors need to own a certain percentage of your company to make investing in your company worthwhile. If you have an ask of 5%, you will not get any investors.”
“But we’re going to worth billions in a couple of years,” the CEO said. “With 5% ownership, investors will make a ton of money.”
“I understand where you’re coming from,” I said. “However, every CEO investors meet believe their company is going to be the next big thing. And most companies are not the next big thing.”
“We will be the next big thing,” he said. “If they don’t want in, then I’ll find other investors.”
“I hear you. But I’ve got to be honest with you. You’re not going to get that type of a deal unless you get really lucky.
“I don’t think I can be of any help to you.” I then quickly ended our call.
The market (potential investors) always determines the valuation of your company.
Experienced investors have tons of experience negotiating investment deals. You likely don’t have any experience.
The worst thing you can do is try and set the valuation. If you set the valuation too high, then you may turn off investors. If you set the valuation too low, then you may leave money on the table.
So, instead you should answer, “We’ll let the market determine the valuation,” if you are asked what the valuation of the company is.
The only way you can increase the valuation of your company is to create competition amongst potential investors. Creating competition is easier said than done. Most companies are lucky to get one term sheet.
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