Yesterday I had discussions with three separate startups about valuation questions. 

One asked how to respond in an investor presentation when the inevitable question comes up:  What are your valuation expectations?  It’s possible to get 5 different answers from the next 5 advisors you consult on this point.  How would you respond?

I went through some math based on an investor expecting a 10X return, assuming an exit value of 8X EBIT based on the company’s 5-year projections, and deriving what percentage would yield that result.  That answer was about half what the entrepreneurs really had in mind, and I must acknowledge that very little weight can be given to projections literally more than a few days out into the future.  But, this calculus does serve the purpose of showing the possibilities.

Another way is to put some beef behind the proposed valuation.  I’ve heard yardsticks like each engineer on the founding team adds $1M in value, particularly so in the Bay Area where companies are sometimes bought and shut down just to acquire the engineering talent for another purpose.  So, things like head count, actual customers, and any other elements of “traction” can help.

In any event, I would always advise against ducking the question.  I’ve often heard in venture séances an answer like:  “We’ll be reasonable and will respond to terms sheets.”  Inevitably as soon as the presenter leaves, someone around the table has already had a conversation with the company and spills the beans on exactly what is expected.   Avoiding the question just never works.

In this particular case we seemed to settle on an approach with a ballpark number that was about 2X what I calculated but was not out of the realm of reason.  The main goal of a séance presentation is to get one-on-one meetings with interested investors in the room.  If you answer with a number that shows ambition but is not delusional, you won’t prevent those next meetings.  In other words, there’s almost no right answer to the question, but there’s a wrong answer that will derail your process.  There’s a fine line between the two.

In another session we got into the subject of traction.  Clearly the valuation steps up incrementally when a product is complete and technology risk is mitigated, and then again when there are some actual customers that prove that at least somebody will pay for and use the product.  The latter begins to move the company from angel funding to A round consideration.

At the very earliest seed stage, I suggested the idea of “conversational” traction.  Two of the aforementioned companies are attacking markets from the outside.  The ideas seem plausible and promising, but I think it’s important to get some meetings with decision makers already in the target industry just to get some genuine feedback on how the game is played.  You don’t want a potential investor to ask whom you’ve met that likes the idea only to find out that you haven’t yet started that person-to-person investigation.  Your research can only tell you so much; you have to get some introductions and go meet the movers and shakers to understand how things really get done in your chosen sector.  Connections are easier to come by than you may realize.  You want that feedback so you can mold your plan accordingly before a potential investor starts asking around and shoots a gaping whole in your idea.

Keep in mind that valuations vary considerably by geography.  Deals that match the Valley interests will be worth much more there than in my hometown of Gainesville, GA.  But, if your business has to do with chicken processing, Gainesville may be the better bet.  I recently had a discussion with an attorney who referred to the valuation on a deal as “laughable.”  I agreed until I realized he was thinking laughably high and I was thinking laughably low.  We were looking at the same facts from very different geographic perspectives.

Comments always welcome.