Investor balancing risk and money on a balance. The four best ways to close the gap between your investor’s valuation and your own.

 

Almost every startup founder has experienced that crushing moment when a potential angel investor reveals how much they believe your venture to be worth. The excitement that you walked into the investor meeting with, is replaced by a sinking joy as you leave.

 

At this stage, most founders double down on their spreadsheets and their decks to tweak revenue forecasts or build a better visual graphic. They hope that by adjusting the light, the investor will better see the valuation the founder has pictured in their own mind.

 

But bigger hockey sticks and snazzier decks are not the cure for valuation gap sickness.

Angels invest at the earliest and most risky stages of a business when the major unknown is still whether the business will work or will not. We pay less when we are unsure that your business will survive to the beautiful future you paint, and we pay more when we see much higher chances of success. Early-stage investors are generally quite skeptical and almost by default, we assume your projections are inflated and that your business’s future outcome is less rosy than you assume. Better graphics and less credible revenue won’t change this, but the more certainty you can provide, the easier it will be to get closer to your valuation view.

 

 

Even before your pitch has ended, we have increased the risks you downplayed in your deck and have started searching for all the ways your business actually could fail. This “what could go wrong?” investor default drives us to offer lower valuations. In our mind, your pre-revenue startup is born with four fundamental risks that must be addressed before we pay up.

 

The lower these four basic risks, the better able you are to persuade us to invest at your price.
I will share these four standard investor risks using the example of a chocolate unicorn business (I reserve 10% equity rights if you take this to market!)

 

1. Concept Risk: How feasible is your idea?

Everyone loves chocolate. Everyone also loves unicorns. And we all need to get around. The world would be a better place if there were chocolate covered unicorns flying us where we needed to go. It just would.

 

From a founder’s perspective, the combination of irresistible sweetness, winged horses, and mass transit surely is worth a few billion dollars from any VC!!! But even though public transportation by chocolate unicorns is an appealing trifecta, when viewed from the investor side of the table, the risk is quite high since nothing like it has ever been done.

 

Concept risk is the first mental hurdle an investor needs to jump. Show any evidence of chocolate-covered horses or even zebras already prancing around and that hurdle falls to the ground. The founder of every well-funded EV company can likely trace their success to the widely watched futuristic Jetson’s TV show that convinced us the concept of strapping a battery to a car could actually work.

 

Reducing the ‘concept risk’ an investor perceives will increase both your chance of funding and your valuation.

 

 

2. Technology Risk: Is it possible to do what you envision?

 

As an investor, I may be genuinely convinced by your evidence that artfully patterned chocolate unicorns are the next step in global mass transport but standing in the way of your lofty valuation is still the unanswered question of whether it can actually be done.

 

Technology risk is the possibility that your visionary product can be physically created. The less possible it is to build your solution today, the higher the risk your angel investor will assign.
As a founder, you must help your investors over this ‘technology development hurdle’. We won’t buy your valuation without first seeing credible proof that this risk won’t sink your business. Even Elon Musk would have received a ‘hard pass’ in the 1950s when there was little technology to suggest that a battery could be both powerful and light enough for a family sedan.

 

 

As the technology developed to make it possible to build a functioning EV, only then did Tesla get higher valuations. Showing a small pilot, an MVP, or other credible technology proof is more valuable than a large questionable revenue number in far-off Year 5.

 

3. Economic risk: Is there a practical economic way of doing it successfully?
You and your investor agree that chocolate spray technology works great on free-range unicorns, but is the business of doing worth what you claim?

 

This point is when many founders mistakenly set out to engineer their way to a higher valuation by adding more and more revenue streams and making bolder market share assumptions.

 

I’ve been there.

I wish I could say the extra sleepless hours fiddling with growth factors ever paid off. They honestly never did. In my years of investing, I cannot recall a time when the sudden appearance of an additional but unlikely customer segment or the immediate doubling of projected revenues resulted in agreeing to a higher valuation. I admit that large numbers do attract attention, but good market fit and scalable traction are way more attractive for valuation purposes. Founders are better off taking steps which increase the certainty, rather than the size of their revenue projections.

 

 

Proving that specific customers will pay your estimated prices will do more to narrow the valuation gap than showing a classic exponential growth curve. Rather than doubting your estimated revenue and discounting your projected growth, your investor will see their investment as a viable path to realizable value for your business.
Reducing business model or structural risk is where most founders can most easily increase their valuation easily. Founders can either work on better PowerPoint ways to convince that chocolate unicorns will be everyone’s choice for transportation in the future; or to prove why leasing is more profitable than selling each unicorn, or they can work on getting early customer orders, taking steps to improve the unit economics or shortening the path to the market, each of which will increase the investor perception of how much the business is worth.

 

Choose to follow Marc Andreesen’s advice: “You’re almost always better off making your business better than your pitch better.”

 

4. Execution Risk: can your team do both day-to-day and long-term business activities well enough to deliver your promised results in a really competitive market?

As hard as creating an idea is, and as hard as developing a product MVP is, successful execution is the hardest thing you will do in business. An investor must be convinced that your team can overcome this ‘execution risk’ and deliver the future you have promised.

 

Unless you have done it successfully before, there are doubts whether you can find enough unicorns, convert enough customers, broker enough deals profitably, hire and lead spray technicians, respond to the inevitable upstart ‘chocolate cow competitor’, and reach and exceed aggressive growth targets to scale your chocolate unicorn venture.

 

The earliest Tesla Roadsters validated the concept, proved the technology, and showed that customers would pay, but Elon Musk still needed to prove that his team could efficiently procure, negotiate, brand, and produce at scale before the investment community met the valuations that Tesla proposed. This is why reducing ‘execution risk’ has the biggest impact on closing the valuation gap.

 

 

Focusing on the ‘most critical’ execution activities and avoiding ‘non-critical’ distraction activity increases investor confidence that an early-stage team can execute successfully and increases the valuation investors are willing to pay. Lower Risks, Higher Price.

 

Entrepreneurs see valuation in terms of revenues. Investors see it in terms of risks. Understanding and reducing these four fundamental risks will help investors give a better price for your early-stage business.

 

 

Kevin Simmons