Project 2012: Day 124
I’ve been getting into Dragon’s Den. I know a lot of people reckon that it’s “not real” and the scenario’s are contrived to create conflict, i.e. good TV. But I disagree. The financiers I know, whether Angel, VC Fund Managers, or even execs, are pretty much just like those in the Den. They ask gnarly questions about revenue forecasts, business models, and returns. They’ve seen it all before, have probably been there themselves, and want to make a return.
The entrepreneurs with their wacky ideas are all very much like the start-up entrepreneurs I’ve met too. Nervous, excited, enthusiastic, blindly optimistic. Some get that it’s not about funky ideas, but about sustainable business. Most don’t.
One of the areas I love watching, and invariably get frustrated by, is when the investors (Dragon’s) ask how much stock they’ll get for their investment. The negotiation.
This is usually a sticking point for the investors too, who themselves get frustrated by the entrepreneurs. Two thoughts:
- Most entrepreneurs (on the show at least) seem to be unaware that this is a negotiation.
- Again most entrepreneurs seem to have almost no understanding of how to value their business.
Let’s start here shall we. Whenever you’re exchanging something, an idea, a command, money, equity, goods and services, you’re in a negotiation. This is true whether you’re asking your three year old to clean up his toys, interviewing someone for a role, or looking for someone to finance your dream.
This point was brought home to me (again) when I financed my bike. I didn’t have to accept the interest rate or terms of one lender. They get value from this deal too (as does the broker), because of this I have negotiating power – I could go with other lenders (there’s always an alternative), I could put more in the loan (more interest for the lender), I could terminate early, or have a residual – any number of options.
The same is true for the financing of a business. There are other financiers looking to make a return. There are other things you need apart from capital. There are other motivations for investors apart from financial returns. You don’t know any of these things until you talk about them.
Generally on the show the investors will make a particularly ridiculous offer. This is negotiation 101. Yet the business owners never counter!! Invariably the more desperate ones accept it as is, and others reject. Wow.
It’s always a good idea to have a conversation about this. “I wanted $100k for 15% of my company, you’ve offered $50k for 15%. Would you be happy with 22% for $100k, and a seat on the board?” Something, anything.
Second it’s best to plan this conversation ahead of time. C’mon, you’ve probably bought or sold something in your life, you know that people are going to try and get something more out of you. So plan this, don’t lead with your full and final, and have an alternative.
More on negotiation in a later post.
The motivation for this post though was the lack of ability of founders to value their company. Of course businesses are worth different things to different people. They’re also worth different things at different times in their life-cycle.
The number of people that go on the show with a “$200k for 10%,” in other words valuing their business at $2m, and they haven’t produced or sold anything, is astounding. It’s like they need $200k, but they want to make 90% of the profits, yet they have no idea how much those profits will be.
So how do you value your start-up? This is particularly difficult when you have no assets, no profitability, and guesstimates at revenue forecast.
Not a bad start would be to look at comparable start-ups in the same industry, with a similar product set & customer demographic, at the same stage (or when they were at the same stage.) This is a well used technique.
Of course you have IP that sets you apart, you’re quicker to market, you have a superior product/service, a more experienced management team, or some monopoly on the market that those other start-ups didn’t have. But that’s ok, better to be slightly undervalued.
Often you’ll be comparing to companies value at exit, then extrapolating back to the stage you’re at.
You’re probably worth what investors reckon you’re worth. Certainly, talk to a number of investors, and other entrepreneurs to get a range of reason. But my experience is that a good investor is likely to be pretty accurate in the worth of the business.
That being said, of course investors are people like the rest of us, and susceptible to influence. To being sold a vision. Bubbles like the dot.com boom (& subsequent bust) demonstrate this clearly. So you can sell your investor on the value of the investment.
Of course, any savvy investor is going to look at your team, question your business and product models, scrub your forecasts, and challenge why this team, with this product, in this market, is a viable investment. That’s ok. Believe me, you need and want that level of diligence. Still, prepare for it. Right?
This valuing thing is a tricky business. My take:
- Be prepared to negotiate
- Be reasonable – only look for funding if there is no possible other alternative. True entrepreneurs get customers.
Next week we’ll look at a tool to help you determine the stage and feasibility of your start-up. Developed some years ago, but valuable nonetheless.
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