Creating a sense of valuation momentum is the sizzle that investors focus on when evaluating early stage companies. As the old saying goes, “if you’re not building value you’re going backwards.” Sometimes it’s just as vexing to communicate the value than it is to generate the value! If considering a potential angel private equity round, here are nine keys that will pique investor interest in backing the deal:
1. Valuation Starts with Team
Your team is always the largest lever in your control and how you build your team will be the most important factor an investor will consider when evaluating your company’s risk/reward valuation. Recently a nutrition tech type company presented to the Keiretsu Forum deal screening that oddly had no team slide in the presentation deck, and sparse detail about the execution plan to provide a return on investment. While we will likely buy some of the product and give it a go, it was a hard pass on the investment opportunity.
We would have liked to see the focus on the team, then the opportunity. When too much of the focus is on hype and not enough on the substance of the team it is typically more of an opportunist than an entrepreneur.
2. Valuation Intention
You absolutely must be able to quickly articulate the math outlining “here we are today, here’s the money in, here’s projected post-money, here’s where we’re trying to get to, and if we do, we should achieve this return multiple.” Articulate your goal, how you will grow, how the company will create value, and what the market potential is that will deliver that upside return.
An existing investor needs to believe you are offering a big market opportunity that’s going to pay a big premium; a new investor needs to know they are coming in at the right time. Intention is such an important part of creating your own success and growing resources available to achieve your goals.
3. Keep Term Sheets Simple
Being non-standard in your term sheet does no good, save for creating additional confusion while increasing the time it takes for someone to clearly understand the opportunity. Instead, keep the term sheet as simple as possible, with a capitalization table and spreadsheet that clearly shows both the current share ownership, and the new investment terms. Pro-forma of the relative percentages, and ownership of the company post-money also needs clear articulation; and impact as the company grows, and raises more capital.
4. Align Capital Plan with Business Plan
Transparency builds trust with investors, particularly if they feel like you have a very good sense of the potential upsides and downsides, and have accounted for that with a built-in buffer. The capital plan matches your structure against your stage of development and accounts for the milestones you achieve to de-risk and build a sustainable business. It provides a flexible road map that adjusts to market realities of capital raising.
Thus make your capital plan to match your business plan. To do such, showcase the alignment between go-to-market business plan, and the alignment between current valuation and capital, vs. the projected business milestones driven by the next round of capital.
5. Convertible Notes, Valuation Discounts
Gain momentum and additional valuation sizzle by using convertible notes as a way of breaking up the round into several trenches. If the price is the same between the first investment and the last investment, investors may wait.
Put a discount for the first third of the round all the way up through the first half of the round. Do those rounds as discounts up to the full round, such that the early investors receive more stock than the last investors. This generates positive impact in the market, creates demand, and further drives momentum. If you’re not selling a huge chunk of stock it becomes only a matter of a few hundred thousand dollars, but a worthy discount in order to generate that momentum.
6. Avoid High Valuations
Be extra conservative around your valuation, particularly when getting the funding round started.
If you price your valuation too high, no one will want to work with you and that will scare off the rest of the investors. Start as low as possible, but limit supply to maximize demand and uptake of your funding round. Once momentum is secured, your funding success and valuation will grow, and the company will have the market working in your favor, not against.
7. Cash in the Bank
The best evidence of momentum is cash in the bank! Businesses are very tough to restart. Adjust plans quarter to quarter, so you keep at least six months of cash runway in the bank. Cash in the bank also underscores for investors that you can execute those very important critical milestones early in the company’s development, build value quickly, and then raise the remaining round of capital that you need to take your product all the way to market.
Use discounted convertible notes with caps, in order to create a significant early incentive for investors to be the first ones to jump and get that first tranche of outside capital into the company. There is a huge difference between having raised no outside capital and closing that first tranche, hitting this milestone will accelerate all your momentum.
8. 40% Valuation Post-Round Rule
A corollary to tip #6: The first thing new investors considering a new round will look for is positive signals from existing investors. If existing investors feel like it’s a great deal, and they continue to invest, that gives a very strong sign to new investors. Adhere to the 40% rule, which is to never increase the value of your company more than 40% between rounds. For whatever reason, once you increase the value more than 40%, it becomes very difficult to get your existing investors to reinvest in the new round.
9. Stair-Stepping Valuation, Bridge Valuations
Stair-step up your valuation then, don’t just double it which would make it very difficult for existing investors to continue to contribute. Instead, do a bridge round at a 20% or 30% up and then another 20% up. Generally don’t go more than 40% up unless something super fantastic has occurred that absolutely delivers a solid valuation metric to justify that kind of price increase
Nathan McDonald is chairman of Keiretsu Forum, the world’s largest angel Investor group, ranked by Pitchbook in 2021 four years in a row as the #1 most active investment firm, U.S. region/early stage deals; and two years in a row, #1 most active, late stage deals/U.S. region. It has invested $950 million into 1000+ companies to date. Mr. McDonald also manages Keiretsu Capital that invests alongside Keiretsu Forum.