You're negotiating term sheets with startup founders. How do you handle conflicting valuation expectations?

I’ve found it useful to have founders consider valuation as the price an acquirer would pay for their company today… this is a factor of the potential size of their future business, divided by the level of risk to achieve that successful outcome. Asking them what they would pay for their business today if they were [Acquirer X] can be a leveller. The acquirer’s value equation is based on them being better off to purchase the solution (company) rather than build it themselves. Each funding round should be designed to tackle the highest priority technical and commercial risks that build the company’s UVP and UA, shifting the value equation in their favour.

Comprehend the startup's value from both perspectives. Evaluate potential, growth prospects, and current market conditions to form a well-rounded view of the company's worth.

Valuation is crucial, but the overall structure of the deal is more important. For example, it's possible to negotiate a higher liquidation preference or more board rights to agree to a higher valuation or suggest an upside sharing to the founder.

1. Have a transparent conversation to understand the rationale behind each party's valuation. 2. Use comparable companies (comps) in the same industry, stage, and geography to provide a market-based framework for the valuation. 3. Discuss future revenue, profit projections, and the realism of these forecasts. 4. Propose a tranche-based investment where funds are released based on achieving specific milestones. 5. Balance higher valuations with control provisions to protect the investor (e.g., board seats, veto rights). 6. Ensure both parties’ interests are aligned towards the company's success. 7. Incorporate terms such as anti-dilution protection, liquidation preferences, and vesting schedules to safeguard interests

Transparent Communication: Be open about your valuation methodology and the factors you consider important. Mutual Goals: Emphasize that the goal is to reach a fair valuation that benefits both parties and sets a solid foundation for future collaboration. Empathy and Respect: Show understanding and respect for the founders’ vision and efforts, fostering a collaborative rather than adversarial negotiation environment.

The challenge is to build trust by being upfront about your valuation methods. Explain how you arrived at your figures. This transparency sheds light on the process for founders and fosters a collaborative environment. Remember, trust is a two-way street. Actively listen to their reasoning and acknowledge their perspective. This foundation of trust allows for productive discussions and a willingness to compromise.

Data-Driven Approach: Use financial metrics, market data, and industry benchmarks to substantiate your valuation. Detailed Projections: Request detailed financial projections from the founders to understand their growth assumptions and align expectations. Risk Assessment: Highlight any potential risks you see and explain how they impact your valuation. This can include market risks, execution risks, and competitive threats.

Valuation negotiation is a combination of art and science, an extremely demanding people skill venture capitalists have to master. By leveraging a large data set, they are like the bargaining chips on your hand, i.e., The more, the merrier. You should be aware that the data set we talk about involve both external and internal one, which means the research support from market and due diligence findings against the target company respectively.

Negotiating valuation can get heated. Founders, ditch the "founder's tax" mentality (the idea your passion deserves a premium). Instead, focus on data-driven discussions. Prepare financial models with clear assumptions and realistic growth projections. VCs respect a strong understanding of your market and the drivers behind your valuation. Transparency builds trust, paving the way for a win-win outcome.

When opinions clash, data is your secret weapon. Present industry benchmarks, historical data on similar startups, and financial projections to support your valuation. You can encourage the founders to do the same. This shift towards data-driven reasoning steers the negotiation away from subjective beliefs and grounds it in objective metrics. You should find common ground becomes easier when everyone's on the same factual page, paving the way for a mutually agreeable valuation.

Consider creative solutions like milestone-based valuations, revenue share agreements, or convertible notes to accommodate differing valuation expectations. These alternatives can offer a compromise that satisfies both parties.

If valuation remains a sticking point, get creative! Explore alternative deal structures that can bridge the gap. Here are a few options: Earn-Outs: Agree on an earn-out provision, where founders receive additional compensation based on achieving future milestones. This ties your investment to the startup's success and incentivizes founders to deliver strong results. Share Classes: Consider different classes of shares with varying rights and voting power. This allows for adjusting the effective valuation without changing the headline number. Founders can retain control while you secure a better return on investment.

Trade speed of execution for a lower valuation or alternatively the the founder’s desired valuation plus warrant coverage that gets you the effective valuation you want.

Creative Structuring: Propose alternative deal structures such as convertible notes, SAFE agreements, or milestone-based valuations to bridge the valuation gap. Incentive Alignment: Consider performance-based incentives that align the interests of both parties. For example, offering additional shares if certain milestones are met. Equity and Non-Equity Components: Mix equity with other forms of compensation or investment to satisfy both parties’ expectations.

An easy way to do this is if the VC is bringing "know how" to the table (such as industry knowledge, important connections, etc.), then set some sales targets with some ownership interest escalations. Example: When the company reaches $ 10 million in annual sales, the VC ownership increases by 5%.

Balanced Concessions: Be prepared to make concessions, but ensure they are balanced. Both parties should feel they have gained something from the negotiation. Focus on Long-Term Value: Emphasize the importance of a valuation that supports long-term growth and sustainability over short-term gains. Partial Agreement: Sometimes agreeing on a partial valuation and revisiting it after achieving certain milestones can be a fair compromise.

While compromise is often necessary, do it wisely. You may consider the long-term implications of any concessions you make. If the startup's potential is undeniable, a slightly higher valuation might be acceptable in exchange for a larger equity stake or stronger protective provisions in the term sheet. Conversely, for higher-risk ventures, hold firm on your valuation but offer terms with significant upside potential for the founders if they achieve specific milestones. Remember, a strategic compromise creates a win-win situation, setting the stage for a successful long-term partnership.

Clear and Fair Terms: Ensure the final term sheet is clear, fair, and accurately reflects the agreed valuation and conditions. Legal Review: Have legal teams from both sides review the term sheet to ensure all parties are protected and there are no misunderstandings. Transparent Communication: Maintain transparent communication throughout the process to avoid any last-minute surprises and to foster a positive ongoing relationship.

Valuation and price are two different things. Let’s talk about the green without greed (exit potential) and forget equity points. I’d care about the waterfall of how much money goes in and out of this and enabling the founding team to deliver value

When negotiating term sheets with startup founders, my first step is verifying the actual funding needs. Are their workflows and operations optimized, or are they relying on our investment to address inefficiencies? Addressing this upfront can help align their funding requests with their actual needs and foster a more productive discussion.

valuation is negotiated. can the startup demonstrated its value via agreed upon milestones. If there are comparables, what are those comparable startups? can they show me the comparable? How much more value can they show compared to the comparable? Another way to address is to do a SAFE and push the valuation discussion down the road. These are some additional considerations. If there are no comparables, negotiation is the best way forward.

Maintain patience and openness to continued dialogue. Approach negotiations with a cooperative mindset, aiming for outcomes that benefit both parties and support the startup’s growth and success. This attitude can lead to more effective and amicable resolutions.

I wrote an article on how VCs value early stage companies and how raising venture capital affects the cap table, which I implore readers interested in this topic to explore. You’ll find that the earlier an institutional investor allocates towards a company, the greater the risk premium that they will demand in their cost of equity. Using the VC method, Venture Capitalists will back into a companies implied valuation by estimating their target exit valuation and discounting it to its present value, using their target IRR.