The EIR Corner

When seeking capital, the highest valuation may not always be your best choice. Working with an investor that can really add value to your company is often more important than choosing an investor offering the highest price. It is true a higher valuation will result in greater ownership for the management team, but the right investor can help make the company more successful and deliver a better financial outcome.

Although you will certainly want to optimize the value of your business, you do not want a situation where an unrealistic valuation set today will likely be followed by a lower subsequent valuation. This is called a “down round” and it should be avoided. Current shareholders (you and your investors) can lose considerable value because of dilution and new investors tend to shy away from companies with declining values. Although down rounds can be beyond your control (e.g., when a hot economy or business sector suddenly cools), they are most often created by impractical entrepreneurs, amateur investors, or overly zealous venture capitalists.

The best way to avoid a down round is to have a reasonable initial valuation and to raise enough capital to achieve the milestones required to have the next lead investor place a higher valuation.

Valuation also comes into play relative to your exit strategy. All investors have expectations regarding capital returns and might not be willing to exit the company for less. Reviewing your long term forecast and capital structure can provide an estimate of the proceeds from a future liquidation event. Investors will be pleased that you have reviewed this number to ensure it fits their objectives and that you appreciate the role their capital played in creating your wealth.

By maintaining an open and candid dialog, you should be able to negotiate a mutually acceptable number with the investor that can best help your company grow.