In every event I get asked two questions: What is the right valuation for my company and how do I arrive there? How much money should I raise?
Many books have been written about valuation. I’ve got one in my office from my predecessor, about 750 pages thick. I keep it for cold winter nights and the open hearth. Or when I can’t fall asleep. But there are basically three steps you could work on these two questions:
- You know you need $10m to get to the next milestones, but you only want to surrender 30% of the company’s equity. Your pre-money valuation – the valuation before you add the money from the VCs to the pot – is ergo roughly $23m, because the VCs’ $10m of the total post-money of $33m is 30%).
- You realize that a $23m pre-money is probably not what you would expect at no significant revenues with a so-and-so alpha product. So you should seriously think about a lower round and what you could achieve, what that means for the required follow-on rounds, and what impact that might have on scaling, hiring, partnerships, resources, …
- You understand the dynamics of negotiations – from anchors to aspiration points to “Zone of Possible Agreement” (ZOPA) to “Best Alternative to Negotiate an Agreement” (BATNA). You also understand that a private offering satisfies a demand as well as an attitude – a demand and craving by angels and VCs and other investors as well as the risk attitude en vogue. You should read Mark Suster’s post on “Why Startups Should Raise Money at the Top End of Normal” (http://www.cloudave.com/13410/why-startups-should-raise-money-at-the-top-end-of-normal/)
There you are.
In recent meeting I discovered some sort of panic and anxiety when it comes to the first term sheet. You can go to YCombinator and others to download their term sheet. Startup Company Lawyer has many tips and links for the first term sheets at Startup Company Lawyer. Most notably, a posting from March 2010 dives into some details of seed and Series A investment documents http://www.startupcompanylawyer.com/2010/03/14/how-do-the-sample-series-seed-financing-documents-differ-from-typical-series-a-financing-documents/.
Chris Dixon also had good advice on first round terms back in August 2009 http://cdixon.org/2009/08/16/ideal-first-round-funding-terms.
A word of caution: a term sheet is really just an agreement on the terms “on a very high level”. Because the term sheet is only the basis for any legal documents, and only these are binding. But sometimes terms are not easy to put into legal text, especially if you happen to have some existing agreements or legal agreements. I recommend asking you lawyer or advisor a lot of questions to understand where in the legal documents you will find which terms; why the wording sounds so complicated; and what are risks and loop holes of the legal text at hand?
Another word of caution: Any legal document you got signed that talks about certain arrangements for the next round are vapor ware – if you cannot act out of a position of strength. The new investor might simply say “I want that changed” or “I want that taken care of before I lead your next round” – or otherwise the investor walks away. Do not think just because you have a signature on a piece of paper means that the deal is going to go down that way.