Raising capital and negotiating with investors is challenging and ambiguous for startup founders, especially in the early stages. In the article “How to Raise Capital for a Startup- A Road Full of “No” Signs!” We discussed the principles of raising capital. This article will review the negotiation strategies with investors for raising money.
Startup valuation, the main topic of negotiation sessions
For raising capital, one of the most important and controversial issues in the negotiations between the startup founders and venture capitalists is the startup’s value.
The venture capitalist receives a percentage of the startup’s stock in exchange for raising capital. The exact amount of the share is determined based on the money required as well as the startup value. Therefore, the valuation agreed between the founder and the venture capitalist determines the percentage of shares the investor receives.
Wear the shoes of investors and imagine what matters to them.
Before each negotiation, find out the best answers to their potential questions by recognizing what is going on in the investor’s minds. In these discussions, venture capitalists are those who have more experience in negotiations than the founders. In fact, on the other side of the table are experienced pros who have dealt with a large number of startups. However, they consistently receive price signals from the latest transactions in the ecosystem.
In this article, we will look at common investor questions about valuation and their design objectives in negotiation sessions. By understanding the purpose of these possible and common questions, your answers and the negotiation process will be more optimized.
Investor Question 1: How much is the startup valuation after attracting capital, and how much money did you draw?
In answering this question, keep in mind that the investor may use his communication network to have information about your startup’s previous transactions. On the other hand, sharing the valuation number does not affect the capital-raising success process at this stage.
What is the purpose of investors in asking this question?
In the first place, investors want to know how well the startup fits into their fund investment model.
As a founder, you should know that the venture capitalist usually claims a certain percentage of the startup’s stock, depending on the stage of development. For this reason, your startup should be in line with the fund’s investment philosophy in terms of the development stage, field of activity and other criteria.
Consider a fund that typically invests between $ 4 million and $ 7 million in startups in specific areas. If the percentage of shares taken by this venture capitalist is in the range of 11% to 26%, then the pre-investment valuation of startups financed from this fund is in the range of 20 to 30 million dollars. This means that if you are looking to raise surplus capital, you almost have to forget about this fund.
Another reason for this question may be the investor’s curiosity to determine the startup’s devaluation or overvaluation in the previous stage of raising capital.
Venture capitalists hate the startup Down Road- the situation where a startup loses value compared to the previous round. One simple reason is that they are about to enter the startup equity structure. For this reason, the decline in the value of the startup and the consequent reduction in the value of investors’ property is unpleasant for them.
Another logical reason is that the venture capitalist knows that if he accepts the present value, which is less than or equal to the startup’s value in the previous round of raising capital, the founders’ shares will dilute, inevitably affecting their motivation. On the other hand, venture capitalists are reluctant to enter a phase in which the founders’ shares decline.
Another purpose of asking this question is to know whether you have managed your capital correctly in the previous steps. So it is better to be able to convince the investor about the progress you have made with the money received in the last stage.
What to do:
If you have no problem managing previously raised capital, state your primary valuation data explicitly. Otherwise, cleverly prepare sentences that state the reasons and solutions to the problems.
Investor Question 2: What value do you propose for your startup?
The above question is a common one in negotiations. The investor wants to know whether your estimation is in the range of his valuation. In this part of the negotiation, which is highly subtle, we suggested observing the following points.
Instead of a particular figure, try to state your price range. This helps you to lay the foundation for the first price offered in the negotiation.
Expressing the price range gives the investor the message that you have a realistic expectation of the startup’s value and that you have approached them after precisely examining the matter.
In the next step, ask the investor to offer a price based on his experience and the current market situation.
A professional valuation negotiation begins with a price range and continues according to how the other party reacts.
The following phrases may help you in your negotiations:
- In the previous transaction, we reached an agreement with the valuation of X and raised $ Y. (With this answer, the venture capitalist concludes that the valuation should be more than X. because X was for the previous round, and the founders have made good progress to date.)
- The fundraiser took place X months ago and we have made good progress.
- We are aware of the prices offered by various investors, and our expectation is in line with current market trends.
- As a lot of time has passed since the previous capital raising, the market can better express our fair value.
- We are looking for a long-term joint with venture investors, and we are not just looking for the highest valuation number at the moment.
You can also ask how much the investor similar startups are valued at this stage.
Investor’s third question: Will the previous investors also invest in this stage?
Your previous investors have detailed information on key startup metrics, team members’ capabilities, management performance, and competitors’ status. Consequently, new investors want to know whether the previous investors, given their accurate information about the overall performance of the startup, are willing to continue investing or not.
So it is better to have a conversation with your previous investors and discuss their views in the negotiation session.
For example, you can express your answer as follows:
“We know you claim a certain percentage of the stock. We will help you to achieve this. But in this way, we can not ask our previous investors not to use the right to raise capital in proportion to their percentage of shares.”
By saying this, you are reminding the investor that current investors are supportive and aware of the fundraising process; at every stage of raising capital, you respect the rights of previous investors and do not prevent them from reinvesting.
When can you clearly state the value of a startup when negotiating with investors?
when:
- Your investors are novices and do not have much experience in evaluating startups.
- Many investors want to invest in your startup, and your proposed number may speed up the negotiation process.
- You are forced to negotiate with several investors to raise capital because no single investor is willing to finance your startup.
Avoid big mistakes in negotiations.
Prioritize value creation over valuation.
If your first meeting is the one and the last time you see the investor, focusing on valuation makes sense. But the cooperation between the founder and the investor is long-term, and they are supposed to have many meetings and negotiations with each other. For this reason, try to consider other services of the investor, such as communication network, legal, financial and technical advice, as well as his financing in the next rounds.
Prioritize a fair value over receiving more capital from the investor.
Note that by receiving more capital, not only the percentage of ownership shares but also the control and influence of the startup founders on the board and critical decisions are reduced.
So do not insist on getting the most capital. Only claim as much as you need to.
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* This article is based on the writings of Mark Suster, a famous American entrepreneur and venture capitalist.
