Valuation: what price should you go out with

I got a question this morning about getting an external, "objective" valuation with which to go out and raise financing. Here's my typical answer to that:

Early-stage valuations are straightforward to understand. But they have little to do with traditional valuations.

In normal valuation work, enterprise value is the expected value of future cash flows. For early-stage companies, the variance in those cash flows is very high. It's not a meaningful analysis if there's a good chance of your cash flows being zero or you being the next Facebook.

Early-stage valuations are a confluence of many different factors. You can only control some of them. Most important to understand is that a valuation is a market price. It's a price for a very specific asset - shares in your company - at a very specific moment. It's not what your company is "worth" or even what you could sell it for. Those are different market prices.

The way to maximize the market price of a venture financing is to be smart about the negotiations. That's why I tell all founders to never, ever talk about the valuation upfront. For one, it anchors you. If you set too high a valuation, people will walk away. If you set too low a valuation, it will create a ceiling. Bad news, either way.

The right thing to do is figure out the money you need to get to the next value inflection point. Build a model that shows the use of funds and how the investment makes you a much more valuable company. That should be the smallest amount you're looking to raise (plus a buffer). Divide that amount by the highest dilution you'd find acceptable. Now you have the minimum valuation you are looking for.

Figure out a timeline that means you'll get a few offers more or less at the same time. Then you start talking VCs. Stall or rush as necessary to get people onto the same timeline. You want termsheets submitted within days of each other. A sense of competition and urgency can help, but too obvious an auction process will turn people off.

When investors ask you for valuation expectations or "guidance" in meetings, don't answer that. Stress that you're looking for a long-term partner (you should mean it). Tell them your last valuation (if any) and all the progress you've made since. Paint the picture of the upside again. Don't give them a price - offering you a deal is _their_ job.

Once you have several offers, you've created your market. There are lots of unique things about the bidders. You may like one of them more than the others. But now you have liquidity. You can go back to the lower ones, if you like them better, and ask them to increase their bid to match others. Rinse, repeat a few times.

Using this process, many of our founders raise more money and at higher valuations than expected. The dilution (what VCs will own in your company) is often less flexible than the amount raised. A higher amount raised will generally mean a higher valuation.

There are lots of posts out there about valuation not being the most important factor in a financing. That's true, but it's also true that you owe it to yourself to optimize price as one factor of a financing. The process above is the way to do that.