Category Archives: askthevc

Convertible Notes vs. Equity

Over at AsktheVC someone asked:

“Should Entrepreneurs Be Worried About Convertible Notes as a First Financing Event?”

Jason provided a pretty good answer to the entrepreneur’s specific question and I commented about the broader question of VC vs. Angel comfort with convertible notes. It’s worth a read for anyone facing this question. I’ve copied my comment below:

“It can differ by geography, but I’d say that convertible notes are the exception for institutional rounds; whereas they are quite common for angel rounds.

Unless deal speed is critical or there is a huge gap in valuation expectations, VCs aren’t interested in their dollars converting into a valuation their dollars helped create. Unless the VC goes there, I wouldn’t spend too many cycles trying to go debt instead of equity. You want everyone aligned and equity does that best.

Angels can differ widely, however, and if they will accept convertible debt it might be worthwhile. It avoids the valuation dance with an angel and the risk that such a dance results in a valuation that will create problems for the next round. Of course, they may have the same concern as VCs (e.g. their dollars working against their conversion valuation), but not as often.

If it’s a close call, I’d err toward solutions that keep everyone aligned…”

The $64,000 Answer to "What’s Your Valuation?"

This post isn’t about how early-stage companies are valued by investors, nor is it about how entrepreneurs value their babies. No, this post is about answering the inevitable fundraising question: “What’s your company’s valuation?” or “How much of the company are you prepared to sell for this round?“; particularly when asked in the first in-person presentation.

Here’s my advice and, yes, I expect to hear it come back at me the next time I ask for a valuation. Resist the urge to say a number. Resist with all your strength. I know it’s hard because I’ve seen entrepreneurs blurt out a number even within 5 minutes of receiving this advice. Don’t say a dollar figure and don’t say a percentage. I repeat, don’t say a dollar figure and don’t say a percentage.

The $64,000 Answer

Instead, share the following (after you’ve convinced yourself you believe them):
1) We are looking for great partners beyond the dollars and valuation;
2) We understand that valuation is a market concept so valuation is a result of creating an interested market of investors for our company;
3) If we both decide we could be good partners and excited about each other, I’m confident we will find a valuation that works for everyone;
4) Then be quiet and listen (clamping down on your urge to follow-on with a number).

From there you’ll probably get one of the following responses:
a) That’s great to hear, because we’re all about partnering; or
b) That’s a load of crap, tell me the valuation you’re really thinking.

Even if you get response b), I’d suggest reiterating your primary goal is finding the right partners to build your world-changing company. If you can’t leave investors happy with that answer, then, and only then, reference other specific company comparables (not “my friend got X”) and how your research uncovered a range of attractive X to acceptable Y values (reiterating that it’s about partnership first).

Why do I say this?

Because the reality of fundraising is much more fluid and dynamic than saying a number that could immediately kill investor interest. I have seen meetings turn from hot to frozen when a pre-revenue entrepreneur boldly claims he expects a $20M valuation — only because he hadn’t been through the process long enough to realize anything beyond single digits was a deal killer for any quality fund.

If you give yourself and your investors time to learn each other a couple things happen. First, you get a better feel for who you’re partnering with, and great partners could lower valuation requirements that could have killed you earlier. Second, investors spend more cycles learning you and researching your business. You’d prefer valuation conversations to happen after investors have grown their excitement and vested their time/energy into you. That is the better time to discuss numbers that could work for all parties.

Exception Cases

Have I seen it turn out OK by saying a number? Yes. Could this approach waste time? Yes, if you don’t vet the partner expectations along the way. My advice isn’t focused on the exception cases, I’m recommending a path that has the highest likelihood of getting you good VC partners and a termsheet. Because valuation is a relationship and market concept, your biggest levers for affecting valuation are interpersonal and termsheets. Getting VCs to like you first or getting multiple termsheets will reap better results than demanding $20M valuation in the first meeting. If you can resist the temptation to blurt a number, you will be way ahead in building the strongest funding partnership for your company.

Whaddya think readers — any pearls of wisdom from experiencing this process firsthand?

Traditional(?) VC Model: Broken or Forgotten

Stowe Boyd had some insightful thoughts on Miguel Helft’s New York Times article A Kink in Venture Capital’s Gold Chain. That article, at a high level, questioned whether the traditional venture capital model is broken because of excess capital and tight exits.

Stowe and Fred Wilson both noted that the model isn’t broken, it just needs some tweaks. In particular, they both suggest that smaller funds, smaller investments, with smaller exit requirements could be the answer.

I agree with those sentiments, with a slight twist in wording. I don’t see smaller, earlier investments as a tweak to the traditional VC model; rather, I see that as a return to the “traditional VC model”. The late ’90s, early ’00s focus on double digit and triple digit million dollar investments, with hopes of billion dollar exits was an anomoly. The industry was built on investing single digit millions, from modest-sized funds and building sustainable businesses. One twist for some funds might be a focus on quick flips, but that’s not how I learned the business.

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