As an entrepreneur it is your job to build a profitable, replicable and scalable business, providing a solution to a problem or need people want to solve. By definition, your business can have no value, if there are not enough people who value what you offer.
This is just basic logic. Nothing new here. And this is why if you’re looking for investment, one of the key drivers of your valuation is proof of market demand, ideally evidenced not just with market research but with paying customers. Even more ideally, as evidenced by your triple-digit month-on-month customer and user acquisition figures.
While angel and early stage investing is inherently risky, for all their talk, all investors (angel and early stage included) really want one thing – a safe bet that offers huge returns. Don’t we all? Although general investment wisdom dictates if we want a higher return we must accept a higher level of risk, what we really want when we’re investing is low risk, high reward. So if you can show that you’ve mitigated a lot of the risk through traction in sales, customer or user growth, you’re well on your way to achieving a higher investor valuation.
But what if the entrepreneur is building for a market that may not yet exist? What if the entrepreneur sees an opportunity and is positioning the business ahead of a wave for which there is no “proof” yet? Because let’s face it, this happens all the time. This is what a good entrepreneur does. A good entrepreneur will often “see” things coming far ahead of anyone else. There’s a reason entrepreneurs are often referred to as visionaries. Some call it intuition, others call it gut instinct. It’s hard to describe but there will be plenty of you out there who know what I mean.
How then do you convince investors of the inevitably higher valuation that you will place on your business than they will?
Well, the short answer is you don’t.
Because if I have learnt anything through the investment raising experiences of ourselves and other entrepreneurs, is that without concrete “evidence”, you as an entrepreneur can never really expect potential investors to see – let alone fully believe in – what you can see.
In fact, this is a completely unfair expectation when you think about it. As what makes you an entrepreneur is precisely that fact that you can see something that doesn’t yet exist. Inventors have been dealing with this since… forever!
Yes trying to show the “trends” might help. Market research and your previous track record in building visionary businesses might help. But the reality is that as people we are all different. Some are creative, some are analytical. Some run on intuition, others need facts and evidence. Some thrive in risk and uncertainty, and others don’t. Often, what makes for a great entrepreneur makes for a terrible investor and vice versa.
If entrepreneurs needed the amount of proof investors needed before they started putting in their time, effort and money into a new idea or venture, nothing new would ever be created!
On the other hand, if investors (often analytical types who want all the detail, all the “proof” before they can understand if something is valuable or not) could see what entrepreneurs could see, they would be doing it themselves and keeping all the returns. So, the entrepreneurs need the investors and the investors need the entrepreneurs. Symbiosis of the economic kind.
So, coming back to my question. What can you the entrepreneur do about this?
To be honest, I don’t have an answer. Rather, I believe awareness of this dynamic is in and of itself, the answer.
Don’t stop trying to help investors to see and understand what you see. It is their money, you want it, and therefore you have to do whatever you need to do to convince them to trust you with it. But at the same time, don’t spend too much time trying to convince or educate everyone you talk to. Because for most, the stretch will simply be too great. This is where qualifying potential investors is so important. Rather than getting bogged down, frustrated and generally bummed out, you want to be spending more time with those who are most likely to “get it”.
There’s plenty of great advice on how to qualify potential investors but here are three quick questions to ask yourself whenever you’re considering talking to an investor:
1) Do they have experience in, or a knowledge of, our industry or a related industry?
2) Do they have a successful track record of investing in other businesses in our or a related industry?
3) Have they themselves built a successful business in our or a related industry?
If the answer to Question 1 is “Yes”, great – invest the time in meeting with them. “Yes” to Questions 1 & 2… even better.
But beware, even if you get someone with three “Yes’s”, they are still not guaranteed to be able to see what you see. Often times even if they have been successful in an industry in the past, the market has changed since then. Success can sometimes also breed arrogance and this often doesn’t sit well if your vision for the future of your industry might be a disruptive antithesis of how things “used to be done”.
Similarly, this isn’t to say you shouldn’t spend time with investors who score 0 from 3 either. But go into your discussions with your eyes wide open. This will also provide you with some much needed mental protection in those critical formative stages of your new business. Because it’s very easy to be discouraged by negative feedback from potential investors during fund raising. Knowing which investors feedback to take onboard and which to ignore could be the difference between an amazing opportunity never fulfilled, or a terrible opportunity rightly axed.
And don’t blame the investor if they don’t get it. Make peace with the fact that the only investor who will ever 100% understand and believe in your vision before it is a reality – is you. It’s supposed to be that way.
PS. I’ve reached out to some investors and advisors I know. Stand by for their thoughts on this conundrum.
Richard Liew is founder and editor at NZ Entrepreneur Magazine and Espire Media.
An Entrepreneurs Viewpoint: Toby Ruckert, Founder & CEO, Unified Inbox, unifiedinbox.com
Not a 0 or 1 answer from me. “It depends”.
The biggest companies are formed in markets that aren’t fully mature yet. So nobody sees them coming, hence no matter how good an entrepreneur, angel or VC you are, luck makes up a big % of whether stuff works out.
Historically there was always a growth trigger in another market at the same time leading to success: what eBay did for Paypal, Facebook did for Eventbrite. Does it exist for your idea?
The type of factors that investors look for (traction and numbers of any sort) to me is a lot of BS. Look at the aging unicorns etc, it comes down to the size of the idea coupled with timing, not revenues, user numbers or strategy etc.
On another note: Finding investors who want to invest in markets you want to grow in is also a good alignment.
Peter Thiel’s book Zero to One offers good insights on some of the above aspects.
It also helps to understand which investor type you are talking to when pitching your company: http://tobyruckert.com/2013/09/11/3-investor-personalities/
An Investors Viewpoint: Nathan Rose, Director, Value My Venture, valuemyventure.com
“It is their money, you want it, and therefore you have to do whatever you need to do to convince them to trust you with it”. Says it all really. Their money, their rules. This is not an “unfair expectation” – I have yet to see a business model that is so new or impossible to explain that an entrepreneur can’t take steps to give the analytical investors the data they crave.
Entrepreneurs thinking their businesses are worth more than investors will pay is nothing new. Perhaps the entrepreneur really has created something incredible and no-one else can see it. However, it’s much more likely that if they talk to many investors and can’t find a suitor, the problem is in how they are telling the story, or their valuation expectations. Value is based much more on where your company is today, not so much where it “could be” in the future.
That said, to get the valuation outcome you are seeking, I suggest:
1. Get your pitch as high-quality as possible by getting professional assistance, practicing with analytically-minded friends, and anticipating the potential objections ahead of time.
2. Justify your valuation with in-depth analysis. Your valuation will be taken far more seriously as a starting point in a negotiated outcome if you can give good reasons for it.
3. Bring competition into the process. Resist no-shop clauses and exclusivity provisions until an investment is binding. Any time you are negotiating with only one investor, the balance of power is firmly against you.
4. Even a “no” can be valuable, but only if you get detailed reasons why – schedule a chat with the people you unsuccessfully pitched to, and draw out what their thought process was. To get the valuation you want, you may need to gain greater traction.