Typical Deals – is there such a thing?

Many entrepreneurs go into VC discussions with an adversarial mindset--i.e., it’s a negotiation primarily about price. I am absolutely convinced that this is wrong--you will be at odds with yourself as much as with them--you are trying to sell them on the excitement of your opportunity with a goal of getting them to invest--that’s the prime objective. And frankly price is kind of a second or even third order issue. Founders are also worried about dilution, and so a quick fix to the valuation problem is just to take less dollars, or to chisel down the ESOP. VCs throw up all over this approach because it puts more risk on the company--the team must be firm in the socket, the company must have sufficient capital to reach the next value inflection for the next capital raising.

A typical A-deal (where there may be an idea of a product, little or no revenue, but some clear customer engagement and buy-in, and the elements of a team, or at least a strong technical founder and/or a domain business expert) has a pre-money close to the raise, and a pretty common structure is five on five, so $10M post and the VCs would own 50% of the company. Now “typically” their target ownership is 20%, so you might have a little back and forth and settle on VCs 40% (if you have two, and you should because that means more expertise, balance on the BoD, and around $20M in total reserve for your company--early stage VCs typically reserve $10-12M per deal over say three rounds of funding).

The variance around these numbers will be simply based on the detail, revenue or none, team, etc ... Your target post A-round will be to build out your team, launch the product, and validate the revenue/business model as quickly as possible. VCs are much more comfortable paying salaries out of revenue, and funding high risk new product growth out of investors’ money. To build sufficient value to secure B-round financing, you will want say $5M in revenue, a number of tier-1 customers who are evangelists of your product and team, and you will want a new VC who is willing to pay the higher price of B, this will be a later stage VC who is less comfortable with risk, and therefore happy to pay a higher price for lower risk.

In any investment, it’s critical for all parties to be aligned and share a common goal--your VCs want you to succeed, once they invest they are in the boat with you. Whatever they do, it will generally be to make the company as successful as possible. As a founder or BoD member, that’s your goal as well--and we all sometimes let our personal desires cloud that judgment. What the VCs will worry about on valuation is the post funds: i.e., they will want to ensure that the post doesn’t get too high for the planned performance of the company on this round of funding. Can the company realistically build revenue to a level that will justify a good multiple on that post-funding? If the market is uncertain or slow (like now), they will want to keep the post lower, to ensure that the company can perform and will be able to attract another good co-investor for the next round. In the end, the VCs are not buying a car here, they are trying to build a relationship and help build a company. If the relationship is good, and trusted, risk is decreased and everybody wins.

When you raise B, your A-round VCs will invest more money alongside the new VC, at least their pro-rata (i.e., sufficient to maintain their 20% target ownership). If the company does outstandingly well, your existing VCs will not be able to throw enough cash at the B deal to maintain their equity--are they upset? Hell no, they are ecstatic, they can now “carry” the company at a much higher valuation on their books and their limited partners like that a whole lot better than a down round. You are 110% aligned with your series A investors--the only place where there might be friction is if you have an offer to buy the company. Listen to your investors here, they have been through a lot of these offers, and series A is too early to sell most companies. You will usually do much better by building more value (unless its 2000, and you have a $100M offer and they want you to hold out for $1B … long story).

A “typical B might be $7-10M raise on $20-25M pre--the company needs to be on track to be cashflow positive, and either in the groove for an IPO by the end of B, or positioned to be sold for $300-400M. Either way, you will still take on a C-round, either as mez financing pre-IPO, or to seriously ramp revenue and infrastructure.

Finally, given the metrics of VCs funds, all valuations should be about the same--sure, you can get a mining millionaire to invest a million dollars in your medical device company at a great valuation (but what happens when you need $10-20M and larger economic concerns arise). As an entrepreneur, your deal decision should not be driven by valuation; it should be driven by value.