Valuation expert Joachim Blazer came up with a fun little thought experiment: is there a difference between raising money for your startup and selling your house? Well, there should be none. Here’s why:
Sell your house
You want to sell your house.
So:
-You set a fair price
-To ensure you reach many potential buyers, you put your house up for sale on sites like Funda
-You sell to the first buyer who pays the price
-Because there are many potential buyers, each buyer has an incentive to (1) pay a fair price – otherwise someone else will, and (2) act fast – otherwise someone else will.
The potential buyers compete against each other instead of against you.
Sell your shares
You want to raise money.
In 95% of the cases I see that founders ask only 1 more or less random potential investor for a term sheet and a valuation.
What do you think will happen? Three of these things happen most of the time:
-He will he lowball you
-He will stack the deck by putting in favourable terms like anti-dilution and liquidation preference
-He will take forever to decide
You either accept his offer or go bankrupt. You have zero negotiation power because you have no alternatives lined up.
This is a typical conversation I have with founders:
You: I am negotiating with an investor!
Me: That’s great! How many other investors are you talking to?
You: Uhm, none?
Me: Then you are not negotiating. You will have to accept whatever is offered.
Sell your shares – revisited
Fortunately, this is easily fixed.
You want to raise money.
So:
-You prepare a term sheet, which includes a fair price
-You seek out 3-5 potential investors
-You sell to the first investor who pays the price
-Because there are multiple potential investors, each investor has an incentive to (1) pay fair price – otherwise some else will, and (2) act fast – otherwise someone else will.
The potential investors compete against each other instead of against you. It’s just like selling a house.
Joachim Blazer is a valuation expert and corporate finance advisor at Venture Value. He helps founders raise money. Contact him at [email protected]. The original article appeared on his blog.
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