By Scott Meacham
Copyright © 2018, The Oklahoma Publishing Co.
There is no aspect of the relationship between entrepreneur and potential investor that has more opportunity for conflict than the negotiation of the value of the company for the purpose of the investor making an investment.
Every company founder wants the value of the company to be as high as possible so that he or she gives up as small a percentage of the company as possible in exchange for the investment capital needed to drive the company forward.
Across the table, the venture capitalists and angels who are interested in investing in the deal care about the value set for the company, not because we are focused on securing (or protecting) a specific percentage of ownership, but because this value is the ultimate determinant of our return.
The negotiation can become emotional for the entrepreneur, because figuring out startup company valuations is much more art than science. Seed stage companies have little, if any revenue. Break-even is miles down the road. Often, they are creating a market opportunity that didn’t exist before or are disrupting an existing market so significantly that there’s no precedent to use to creditably predict how fast and how much the company will or won’t grow. Plus, there is the high rate of failure involved in any startup that makes investors require an appropriate risk adjusted rate of return.
I’m a strong believer in entrepreneurial vision and intuition, but experience teaches that entrepreneurs who insist on following their instincts when it comes to sky-high valuation are nearly always making a serious mistake. Too many entrepreneurs press for the highest valuation possible, when, counterintuitive as this might be, a high initial valuation for a startup may be setting the young company up for future failure.
The higher the valuation, the faster and larger the company has to grow to not only meet the financial goals of the initial investors, but, more importantly, to attract critical follow-on investment after that first VC round. In this regard, entrepreneurs will be well-served to think like VCs who understand the pain of devalued investments when the starting valuation of the company was too high.
When it comes to valuation, the best outcomes are achieved when entrepreneur and investor work together to reach a valuation that aligns the interests of the startup and its founders with the investment goals of the right VC. There is nothing to be gained when the two parties most vested in the success of the company become contentious adversaries before a deal is even struck.
When investors and entrepreneurs use the valuation process to share information as fully as possible, the foundation is set for an open and trusting relationship, a relationship that can help both parties weather the tough stretches when they come, as they always will, in every startup company.
Scott Meacham is president and CEO of i2E Inc., a nonprofit corporation that mentors many of the state’s technology-based startup companies. i2E receives state support from the Oklahoma Center for the Advancement of Science and Technology and is an integral part of Oklahoma’s Innovation Model. Contact Meacham at [email protected].