by Randell Young, General Partner, Cache Creek Partners
Here is a hot tip and a bit of inside information: VCs will negotiate aggressively and take as much as they can get; however, if an opportunity looks like a good bet to achieve an outstanding internal rate of return, just about any size raise can be closed by selling off a 25 to 35 percent stake in the venture.
Here is another hot tip. When they ask, “What’s your pre-money valuation”, say “zero”. Don’t play the pre-money/post-money game. You are not liquidating the company. You are organizing resources to pursue an opportunity. One of those resources is cash.
If you can convince a venture capitalist that, given the opportunity you have identified, the technologies you have created and/or adapted or intend to create and/or adapt, the business strategy you have developed, the team you have recruited, a lot of focused effort and a little bit of luck, you have a reasonable chance to achieve an outstanding return, you can get that cash in exchange for a 25 to 35 percent stake in the project.
If you can make a strong, rational case that you can deliver an attractive internal rate of return on the money to be invested, your so-called “pre-money valuation” will suddenly become meaningless. So, rather than try to establish some more or less arbitrary current value, focus on how what you bring to the table facilitates the achievement of that attractive return.
Of course, your investors are going to want representation on your board of directors. They are also likely to want a “golden vote” on certain issues. This means that on certain matters, the VC gets to make the call. This is a far cry from voting control of the company. As long as your investors do not get a golden vote on replacing the CEO, you’ll be fine.
There is a school of thought which contends that, at some point, a “professional manager” needs to be brought in to run the company. The founding CEO did a great job of bringing us to annual sales of _____ but now we need a more experienced operator, usually someone who went to the same business school as we did, to take us to the next level. This theory didn’t work out so well for Apple when they replaced Steve Jobs with John Scully. In fact, it’s been a disaster almost everywhere it’s been tried. Nevertheless, it still holds credence for a large percentage of investors across all categories including angels and professional VCs.
There is another school which contends that the CEO who recognizes and advances an opportunity to the level at which investors are willing to put capital at risk will almost invariably have an unusual and unique collection of talents, insights, experience and expertise which is, for all practical purposes, irreplaceable. This school maintains that mistakes will be made, that solutions will have to be found and course corrections will have to be navigated but that there really is no one better qualified to carry the ball into the end zone than the CEO who got us down to the red zone in the first place.
More often than not, the best results will be achieved where both CEOs and MGPs heed the advice of investor Ross Perot: “The builders must have control.” Yes, there are VCs that do not support the Perot approach but it is a myth that all VCs will demand control and walk away if they don’t get it. Most VCs understand that they are investing in the CEO as much or more so than they are investing in the technology or business concept. If you stick to your guns, you can cut a deal with a VC at an attractive valuation and maintain voting control.
