There is one trick question that investors almost always ask, and it’s guaranteed to make founders uneasy: “What are your expectations surrounding valuation?”
For most founders, it’s the perennial Goldilocks scenario. Throwing out a number that’s too high might push investors away, while an amount that’s too low might trigger the question, “Why so low? What’s wrong with this business?” and leave shareholder value on the table.
And if it’s just right, most investor’s knee-jerk response goes something like this: “Let’s see how much I can work this founder down to a better price.”
Founders are at a distinct disadvantage in the valuation game. By design, investors play this game far better than most founders ever will — a VC might do multiple deals in a quarter, but a founder might approach markets only once every couple of years.
So, instead of having to throw out specific numbers that will inevitably be challenged, here’s a solution:
Don’t throw out a number
The more you seek to understand your investors’ thoughts on deal-making, the better you’ll be at getting to that deal.
The most confident (and valuable) founder response to the infamous valuation question starts with: “We’re letting the market price this round.”
When delivered correctly, it implies you’re taking offers, you aren’t desperate and you’re confident you’ll close a deal at acceptable terms.
But if that’s all you say, 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 baseline indication of your expectations if you actually want to close a deal.
Jay Levy, co-founder and managing partner of Zelkova Ventures, explains, “When speaking with VCs, founders should give some indication of their valuation expectations coming into the conversation. It’s important to know that everyone is on the same page, because it would be painful and unfortunate for everyone to advance toward a term sheet only to realize that expectations are misaligned.”
Gather your valuation data points
To substantiate your market-based valuation approach, you have to begin early. Start by pre-pitching the investors for your next round to gather valuation data points and have low-stakes conversations to build in the presumption that “we’re probably too early for you, but in 12-15 months, we’ll most likely be a great fit.” In these chats, always ask how they might approach valuing your company when the time would be right (i.e., in your next round, 12-15 months from now).