Creating a sense of valuation momentum is what investors focus on when evaluating early-stage companies. Sometimes it’s just as vexing to communicate the value than it is to generate the value. If considering a potential angel private equity round, here are nine keys that help better frame a company’s valuation, and drive investor interest in backing the deal:
1. Valuation starts with team
Your team is always the largest lever in your control and how you build your team will be the most crucial factor investors will consider when evaluating your company’s risk/reward valuation.
Recently a nutrition tech type company presented to the Keiretsu Forum deal screening that oddly had no team slide in the presentation deck, and sparse detail about the execution plan to provide a return on investment. While we will buy this product and give it a go, it was a hard pass on the investment opportunity.
We would have liked to see the focus on the team, then the opportunity. When too much of the focus is on hype and not enough on the substance of the team it is typically more of an opportunist than an entrepreneur.
2. Valuation intention
Existing investors need to believe you are offering a big market opportunity that’s going to pay a big premium; new investors need to know they are coming in at the right time. Intention is such an important part of creating your own success and growing resources available to achieve your goals.
Thus, you must be able to quickly articulate the math outlining “here we are today, here’s the money in, here’s projected post-money, here’s where we’re trying to get to, and if we do, we should achieve this return multiple.” Articulate your goal, how you will grow, how the company will create value, and what the market potential is that will deliver that upside return.
3. Keep term sheets simple
Being non-standard in your term sheet does no good, save for creating additional confusion while increasing the time it takes for someone to clearly understand the opportunity. Instead, keep the term sheet as simple as possible, with a capitalization table and spreadsheet that clearly shows both the current share ownership, and the new investment terms. Pro-forma of the relative percentages, and ownership of the company post-money also needs clear articulation; and impact as the company grows and raises more capital.
4. Align capital plan with business plan
Transparency builds trust with investors, particularly if they feel like you have a sense of the potential upsides and downsides and have accounted for that with a built-in buffer. The capital plan matches your structure against your stage of development and accounts for the milestones you achieve to de-risk and build a sustainable business. It provides a flexible road map that adjusts to market realities of capital raising.
Thus make your capital plan to match your business plan. To do such, highlight the alignment between go-to-market business plan, and the alignment between current valuation and capital, vs. the projected business milestones driven by the next round of capital.
5. Use convertible notes and valuation discounts
Gain momentum and additional valuation sizzle by using convertible notes as a way of breaking up the round into multiple trenches. If the price is the same between the first investment and the last investment, investors may wait.
Put a discount for the first third of the round all the way up through the first half of the round. Do those rounds as discounts up to the full round, such that the early investors receive more stock than the last investors. This generates positive impact in the market, creates demand, and further drives momentum. If you’re not selling a huge chunk of stock, it becomes only a matter of a hundred thousand dollars, maybe a few hundred thousand dollars, but a worthy discount to generate that momentum.
6. Avoid high valuations
Be extra conservative around your valuation, particularly when getting the funding round started. If you price your valuation too high, no one will want to collaborate with you and that will scare off the rest of the investors. Start as low as possible, but limit supply to maximize demand and uptake of your funding round. Once momentum is in full swing, funding success and valuation will grow, and the company will have the market working in your favor, not against.
7. Stair-stepping valuation with bridge valuations
Stair-step up your valuation then, don’t just double it which would make it exceedingly difficult for existing investors to continue to contribute. Instead, do a bridge round at a 20% or 30% up and then another 20% up. Generally, don’t go more than 40% up unless something super fantastic has occurred that absolutely delivers a solid valuation metric to justify that kind of price increase.
8. 40% Valuation post-round rule
Adhere to the 40% rule, which is to never increase the value of your company more than 40% between rounds. For whatever reason, once you increase the value more than 40%, it becomes more challenging to get existing investors to reinvest in the new round.
9. Cash in the Bank
The best evidence of momentum is cash in the bank! Businesses are very tough to restart. Adjust plans quarter to quarter, so you keep at least six months of cash runway in the bank. Cash in the bank also underscores for investors that you can execute those important critical milestones early in the company’s development, build value quickly, and then raise the remaining round of capital that you need to take your product all the way to market.
Brianna McDonald is president of Keiretsu Forum Northwest, part of Keiretsu Forum, the world’s biggest angel investor network ranked by Pitchbook #1 “Most active investors, early stage U.S. region” and “Most active investors, late stage U.S. region.” Brianna is adept at screening companies for angel investment, coaching companies on presentation and investor relations, sales strategy execution, relationship management, and leading due diligence teams. Brianna believes in companies that have “multiple bottom lines,” with a focus not solely on profits but also impact, social good, diversity, and making the world a better place for the next generation.
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