Remarkable by David Kronfeld

Author:David Kronfeld [Kronfeld, David]
Language: eng
Format: epub
Tags: Business & Economics, Personal Success, Careers, General, Self-Help, Personal Growth, Success
ISBN: 9781953295972
Google: u_0xEAAAQBAJ
Publisher: BenBella Books
Published: 2021-09-07T23:20:07.109953+00:00

Starting a “War” Instead of Winning a “Battle”

A scientist invented a new technology around which he wanted to build a company. He approached various venture capital firms to raise the necessary money to launch a start-up. We listened to his pitch and liked what we heard. We told him that we would be interested in potentially proceeding with him.

From our experience, one of the greatest impediments for striking a deal with such scientists/founders is their exaggerated perception of the value of their newly founded company. In the venture capital world, this value is referred to as the “pre-money valuation” of the company. It is an important concept since it determines how much ownership the venture capitalist (VC) receives for its investment in a company. Conversely, it also determines how much ownership the founder will retain.

To determine the amount of ownership, the venture capitalist assigns a monetary value to what the founder created before the contemplated transaction, which is the “pre-money valuation.” The pre-money refers to the value before our money goes in as an investment. Once that value is determined, the percent ownership is determined by a mathematical formula.

For example, let’s assume that the VC assigns a value of $10 million to the company (that is, a $10 million pre-money valuation). Let’s further assume that the VC will invest $5 million in cash. Thus, the total value of the enterprise after the $5 million infusion of cash from the VC is $15 million (i.e., the $10 million cash equivalent the founder brings to the party, plus the $5 million the VC brings to the party). The $15 million is referred to as “post-money valuation” (that is, the company is worth a combined cash and cash-equivalent value of $15 million). The VC contributes $5 million of the $15 million, or $5/$15 = 33.33 percent of the value. The founder brings $10 million of value, or $10/$15 = 66.66 percent of the value. These proportions thus represent the percent ownership of the company after the consummation of the deal. Clearly, every founder will try to negotiate the highest pre-money valuation for their company, since the higher the pre-money valuation, the higher will be their percent ownership.

As I mentioned, most founders have an exaggerated estimate of what their company is worth. They think their company will be worth billions of dollars in the future, ergo it must be worth hundreds of millions today. VCs look at it differently. Although the estimated potential may be realistically great, most companies never get there. “Exits” occur much earlier and at much lower valuations, reflecting real performance, not some exaggerated potential beliefs. VCs place a more realistic expectation on performance and potential exit values. The pre-money valuation the VC would be willing to offer is mathematically driven from that exit value.

Let’s assume the VC places a $300 million exit valuation. The VC will then estimate how much money they will need to invest to make it happen. They require a certain multiple return for their investment. Thus, they know exactly how much of the company they need to own to get that multiple return.

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