One of the first things I do when I engage with a company as their "Sherpa" is to help them raise money. Quite often, if not all the time, they get asked by VC's in pitches: "What are your valuation expectations?"
Here's the wrong answer (the "Wrong Answer"): giving a specific dollar figure, even if phrased as a range (e.g., "...oh, it's somewhere between $X and $Y.").
Here's the right answer (this, or something very close to this -- the "Right Answer"): "We want to set the company up to succeed, and we know you need to have a substantial return to make your business model work. We're reasonable people, with good, experienced advisors who know what the market valuation data, and VC minimum ownership requirements, are -- and we understand that the market will set the price."
Smart VC's will ask (one or more versions of) this question repeatedly, ratcheting up the pressure (even if in a low-key tone of voice). And, it's very hard for an entrepreneur to resist the temptation to answer. After all, most entrepreneurs do, in fact, have some sense of what they think an acceptable valuation is, and, on its face to an inexperienced entrepreneur the questions seems like a reasonable one. Furthermore, while sitting in a meeting as an invited guest in the offices of the VC firm, it might even seem rude to resist giving a straightforward answer.
But, entrepreneurs should.
It will be difficult, given the reasons above, plus the strong power asymmetry inherent in the entrepreneur <-> VC relationship, where one person desperately needs the money and the other person has the money (e.g., "...will I blow my chances with this VC if I don't give him the number?").
But, entrepreneurs should.
Entrepreneurs should understand that the goal of the repeated questioning is to "pressure" the entrepreneur into feeling like he has to give the Wrong Answer or his chances of getting an offer from the VC are slim.
Why do VC's ask the question and what's so bad about giving the Wrong Answer?
VC's, like the rest of us, are time-starved and don't want to spend time on deals that are not worth pursuing. One quick, easy way to triage one's deal flow as a VC is to avoid spending time on deals, even if they are otherwise interesting, where the entrepreneurs have unrealistic valuation expectations. Especially in bubble times like the present, entrepreneurs can, in fact, be way off base in terms of their valuation expectations, and VC's want to find this out early in the process so they don't waste time.
So, why resist giving the Wrong Answer and remain steadfast in (some version of) the Right Answer. Here's why: it's a version of the reason a famous, old-school Ohio State football coach, Woody Hayes, supposedly said why his teams didn't throw many forward passes: "There's three things that can happen, and two of them are bad!" [i.e., an incompletion and/or an interception.]. When en entrepreneur gives the Wrong Answer, he can:
- Give a number that's too low (i.e., lower than the VC had in mind), thereby potentially leaving money on the table.
- Give a number that's too high (i.e., higher than the VC had in mind), thereby helping the VC to make the decision to pass.
The fundamental reality here that underlies this analysis and advice is that, no matter what the entrepreneur thinks, in both of the above cases, the VC "market" (as thin and inefficient as it is) will set the price. Whatever the entrepreneur thinks his company is worth means nothing if no investor thinks it's worth that much. And, as I've argued here and here, getting more than one VC interested in one's company is the only way to discover the maximum price that the market will bear.
In the third "Woody Hayes" case, giving the VC a number that is near the valuation (or valuation range) that the VC had in mind offers no advantages to the entrepreneur over the Right Answer, so why take the risk?