How to Talk About Valuation When a VC Asks

As an entrepreneur seeking funding, one of the most challenging aspects of the fundraising process is discussing valuation with potential investors. VCs are inundated with investment opportunities and have a better understanding of market valuation than most entrepreneurs. However, there are strategies that entrepreneurs can use to better understand the VC's mindset and negotiate effectively.

One question that VCs may ask is about the post-money valuation of your last round of funding and how much capital you've raised. While it can be tempting to avoid answering these questions or downplaying the numbers, it's essential to be transparent. Most VCs have access to databases like Pitchbook, and the answers to these questions will not be a surprise to them. Additionally, VCs use this information to determine whether the startup is a good fit for their portfolio and to evaluate the startup's capital efficiency.

Another common question is about the entrepreneur's expectations regarding valuation. It's important to avoid naming a specific price but to give the VC a general range. This anchors the conversation while giving room for negotiation. Asking the VC for their perception of how the market is currently pricing rounds can also provide valuable information and help you gauge the VC's interest.

It's also essential to discuss existing investors' participation in the current round of funding. VCs will want to know that the previous investors support the startup and that the entrepreneur has considered their opinions. Entrepreneurs should be confident that they can balance the needs of both new and previous investors.

While discussing valuation can be challenging, it's a crucial part of the fundraising process. Entrepreneurs who are transparent, anchor the conversation, and balance the needs of all parties involved will be better equipped to negotiate effectively and secure funding.

Are your existing investors participating in this round?

When you are talking to potential investors in a fundraising round, it is not uncommon for them to ask if your existing investors are participating in the current round. This is a delicate question, as existing investors can have a significant impact on the success of your fundraising efforts.

On the one hand, if your existing investors are supportive and plan to invest in the current round, this can be a positive signal to potential investors. It indicates that your current investors have confidence in your business and are willing to continue to invest in it. This can make potential investors more likely to invest as well, as they see that others have already committed to the business.

On the other hand, if your existing investors are not participating in the current round, this can be a negative signal to potential investors. It may indicate that your current investors have lost confidence in your business, or that they see better investment opportunities elsewhere. This can make potential investors more hesitant to invest, as they see that others who know your business well are not investing.

So how should you handle this question when it comes up? First of all, it is important to have a good understanding of your existing investors' plans. Before you start fundraising, you should have conversations with your existing investors to see if they plan to participate in the current round, and if so, how much they plan to invest. This will give you a better sense of how much additional capital you need to raise and what your fundraising goals should be.

Assuming that your existing investors are supportive and plan to participate in the current round, you can answer the question like this:

"Our existing investors of course want to participate in this round. They will likely want to do their pro rata investments - some might even want slightly more."

This answer indicates that your existing investors are supportive and plan to invest in the current round, which can be a positive signal to potential investors. It also indicates that your existing investors are not taking up all the available space in the round, leaving room for new investors to come in.

However, it is also important to acknowledge that new investors will likely have ownership targets they want to hit, and may not want existing investors to take their full pro rata investments. You can address this by saying something like:

"I know that new firms have ownership targets. I feel confident I can meet these. If it becomes sensitive between a new investor's needs and previous investors - I'm obviously not going to tell my investors they can't participate, but I feel confident I can work with them to keep the sizes of their checks reasonable."

This answer indicates that you are aware of the potential conflict between existing and new investors, and that you are willing to work with both to ensure a successful fundraising round.

If your existing investors are not participating in the current round, you can still answer the question honestly while trying to put a positive spin on the situation. For example:

"Our existing investors have been incredibly supportive of our business, but they have other investment priorities at the moment and have decided not to participate in this round. However, we have a strong group of new investors who are excited about our business and see great potential for growth."

This answer acknowledges that your existing investors are not participating, but emphasizes that you have a strong group of new investors who are excited about your business. It also indicates that your existing investors still support your business, which can be a positive signal to potential investors.

In general, it is important to be honest and transparent when talking about your existing investors in a fundraising round. If your existing investors are supportive and plan to participate, that can be a positive signal to potential investors. If your existing investors are not participating, it is important to acknowledge this fact while emphasizing the positive aspects of your fundraising round, such as strong interest from new investors.

When SHOULD you name a valuation expectation?

Naming a valuation expectation can be a tricky decision, as it can potentially limit your options and lead to missed opportunities. However, there are some situations where naming a valuation expectation may be beneficial.

One such situation is when you are dealing with strategic investors rather than traditional VC firms. Many strategic investors do not like to lead rounds and may not have the same level of experience or understanding of valuation as traditional VCs. In these cases, naming a valuation expectation can help them evaluate the deal more easily and make a quicker decision.

Another situation where naming a valuation expectation may be appropriate is when you are raising from many investors, rather than a small number of lead investors. This may be because you have not been able to secure a strong lead investor, or because you have so much demand that many investors are interested in participating with smaller checks. In either case, having a clear price target can help you build momentum and close the round more quickly.

However, even in these situations, it is important to be flexible and open to negotiation. Just because you name a valuation expectation does not mean you cannot adjust it based on feedback from investors or market conditions. It is always better to have multiple options and be able to choose the best deal for your company, rather than being locked into a specific valuation and potentially missing out on better opportunities.

Turning the information tables

Finally, turning the information tables can be a valuable tactic when it comes to discussing valuation with a VC. By asking the right questions, you can gain valuable insights into how investors are seeing market valuations in the current funding economy and how they perceive your company's valuation.

Some good questions to ask include:

• Does your firm have a target ownership range?
• Do you typically like to lead and do you ever follow?
• Are there firms you like to co-invest with?
• Does our fundraising size sound reasonable to you?
• Are there any valuation concerns you might have that we can address now?

Asking these types of questions not only helps you get a better sense of what investors are looking for but also demonstrates your interest in building a relationship with them beyond just securing funding.

In summary, discussing valuation with a VC can be a challenging task, but it's an essential part of the fundraising process for any startup. By understanding the VC's perspective, being prepared with data and analysis, and effectively communicating your company's value proposition, you can increase your chances of securing funding at a fair valuation. And by prioritizing the right investors, engaging with existing investors, and turning the information tables, you can also gain valuable insights and build strong relationships that can help your company succeed in the long run.

Some tips for startups on how to approach valuation conversations with investors.

1. Research and understand the market: Before approaching investors, it's important for startups to do their due diligence and research the market to understand the typical valuations for companies in their industry and stage. This will help founders to have realistic expectations and be better prepared for valuation discussions.
2. Develop a clear and compelling business plan: A strong business plan that clearly outlines the startup's mission, vision, goals, and growth strategy can help investors understand the value proposition of the company and how it will generate revenue and achieve profitability.
3. Build relationships with investors: Building relationships with potential investors before raising funding can help startups establish trust and credibility, which can be beneficial during valuation negotiations. Founders can attend networking events, participate in pitch competitions, and reach out to investors through LinkedIn or other channels to start building relationships.
4. Be open and transparent: Founders should be transparent about their financials, including how much capital they have raised, their burn rate, and their current valuation. Being open and honest can help establish trust with investors and facilitate more productive discussions about valuation.
5. Understand the investor's perspective: Investors are typically looking for a return on their investment, which means they will be focused on the potential for the startup to generate revenue and achieve profitability. Founders should be prepared to discuss their growth strategy, market potential, and competitive landscape to help investors understand the value proposition of the company.
6. Negotiate from a position of strength: Founders should approach valuation negotiations from a position of strength by having multiple investors interested in their company, a clear understanding of the market, and a strong business plan. This can help founders negotiate more favorable terms and achieve a higher valuation.
7. Be flexible and willing to compromise: While it's important to negotiate from a position of strength, founders should also be willing to compromise and adjust their expectations based on feedback from investors. A willingness to compromise can help facilitate more productive discussions and ultimately lead to a successful fundraising round.

Conclusion

Talking about valuation with investors can be a challenging and intimidating process for startups. However, by doing their due diligence, building relationships with investors, being transparent, understanding the investor's perspective, negotiating from a position of strength, and being flexible, startups can approach valuation discussions with confidence and increase their chances of securing funding at a favorable valuation.