Special to Seattle24x7
Q. How much ownership does a VC take of a high tech startup company? What should I be aware of?
A. It’s quite common for startup entrepreneurs to use the word “take” when asking angels and venture funds to give them money. This revealing word choice represents every entrepreneur’s fear that a slick investor will take advantage, take control or take over the company altogether. That’s why you and other entrepreneurs repeatedly ask “What will they take?” “How do I know if they are setting me up for failure?” or “What will come back to haunt me?”
Previously, I wrote a column on steps entrepreneurs can take to keep their executive role after receiving VC funding. I noted that if the entrepreneur is meeting key development milestones and not suddenly steering the company in an unexpected direction, then the entrepreneur’s position is generally safe.
Another factor that might affect a founding CEO’s longevity with a company is the pricing or “pre-money valuation” of the company’s early stage seed and venture rounds.
Dan Rosen, a veteran venture investor, provides the following experienced perspective, “Sometimes CEO’s can be too short-sighted in seeking top dollar valuations for their startup or early stage companies. When investors pay more, they expect more in terms of management performance.”
Rosen warns that when CEO’s miss key goals, their leadership is vulnerable to challenge by let down investors. And if the company is desperately in need of more capital, the company will likely face an excruciating “down round” ” in which the rescue investment round is priced well below the first round. While every early investor loses in a down round, founding management loses far more in terms of share dilution and credibility. It’s a Herculean task to recover this lost ground.
There is an old Wall Street expression that seems to fit today’s frothy venture market. And it is, “Hogs get slaughtered.” (Substitute “pigs” for even greater emphasis!)
If you are at all uncertain of the timing of key operating milestones or anticipate that you will need several rounds of capital to achieve your goals, it may be safer and less costly to pursue a fair valuation rather than a premium valuation. This way you have a little more leeway to steadily improve your company’s operating position on an investment round to round basis.
So, how do you determine a fair number for your business? Frustrating, but true, there is no consistent or quantifiable way to value startup technology businesses. As such, investors look to qualitative evidence of potential fast revenue growth and competitive technical advantage to estimate a young company’s value.
In VC-speak, these points are called “investment fundamentals.” Obviously, the more fundamentals you can present to investors, the greater your negotiating position. Heightened interest in your target industry “space” among Silicon-Forest, (San Francisco to Portland to Seattle), Austin, and Boston-based angels and VC funds also tends to lift young company valuations.
Before making first investor presentations, it’s worthwhile to consult Perkins Coie, Davis Wright Tremaine, DLA Piper Rudnick Gray Cary, or other law firms that specialize in venture transactions. These firms can provide information on the valuation climate and points of negotiating flexibility. Also seek out technology entrepreneurs who have recently received startup funding, active angel investors and angel forum groups for added tips on valuation pricing.
It’s important to remember that the best investors offer so much more to startup entrepreneurs than just cash. As a balance to today’s discussion of what investors take in venture transactions, come back next week for some thoughts on what angels and VC can give to entrepreneurs too. [24×7]
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