Deserve goddammit, don’t demand

“How high a valuation can you get us from investors…?”

On the face of it, there is absolutely nothing wrong with this question from an entrepreneur.  In fact every entrepreneur must.  But not everything is right with it if it happens to be the only question that you field while you consider working with an entrepreneur in his VC pitching initiative.  It means the entrepreneur has a horrendous screening process whereby he chooses to work with someone who bids the highest even before he diligences them.  Worse still, if their attitude doesn’t let you review their business plan or executive summary ( can’t be wrong….we are Ivy league…!!! ).  All they need you for is just to “negotiate” on their behalf to get the most bang for the buck.  Wuff…self righteousness stretched too far – or is it just plain arrogance…?

I recently faced it from some first time entrepreneurs, seemingly brilliant team with proven business model with some early revnues.  Normally this breed is viewed as people who are deeply clued in about the psyche of investors and their risk-reward framework. It was a bit awkward to explain the basics of valuation to people who are supposed to be knowing it. 

At first they wanted me to sign a 3 year NDA.  Trying to create an aura around their technology which by now has almost become a cottage industry.  You don’t sign NDA with companies which are in a highly competitive sector, have a few products which have enormous competition ( my first random Googling yielded 42,500 results ),  technology is neither bleeding edge nor disruptive – simply put, nothing confidential about it.  I refused to sign it unless they compensate me for loss of  my opportunity that it might entail.

Sanity must have prevailed when they got back. This time with a high sounding Executive Summary.  ( – ah, yes, ` we are from Ivy league’  found mention 23 times in it in one form or other…! ) After several meme passages and look-at-how-great-we-are bragfest,  my `distilled’ version ( I do it all the time with boring summaries )  looked something like this.

– Company in telecom sector ( CRM / Enterprise space ),  founded in 2003 ;

– Product suites notch up a revenue of close to $1.2 MM in 2006 

– Active in the SME segment customers ; 

– 5 year projections indicate touching a revenue of  $ 190 MM by 2012 ; 

– Estimated market size $ 10 billion ;

I tagged it like this.  Brilliant team / average product / no marketing alliances / Arrogant zealots.

I quizzed myself  – why is the company targeting only 1.5% of the market even after 5 years from now…?  Is it not confident enough to get ahead of competiton…?  Or is it just lacking in ideas…?

Then I scanned the competition.  I got all my answers.

There are at least 3 real big players in the segment ( Avaya, Cisco, Nortel ) threatening to wipe out the entire lower stream in terms of cost / quality / features. They spend heavily in R&D and are miles ahead of these hedgehogs. The only advantage our guys have is that of  being small and hence nimble by default.  But that advantage is stymied to a great extent since these guys do not have the market outreach.  The big players have terrific logistics network and a good tech support backup.  They can always acquire customers by throwing in some freebies for good measure and by saying “stick with us – we are big.  Don’t take that road,  it leads to nowhere.”   Many customers will bite that argument. 

If that was the story with the big ones, even other mid segment players were eye openers.  There was this company founded in 1997, notched up revenues of $1.6 MM in first year of operations and by 2005,  were doing $ 62 MM.  ( 39 times growth over 6 years ). All this supported by over 240 resellers, presence across 64 countries and their software application having been released in 20 languages.  And… And…And  they were spending almost 30% of their annual revenues in R&D just to retain their market share thro sustained innovation.  Such futuristic initiatives had shrunk its net profit margin to under 5%,  no dividends to shareholders so far and yet the market gave it a thumbs up by giving a PE multiple of an amazing 51 times its EPS of 13 cents.   Stacked against this,  our Ivy leaguers are doing $1.2 MM in their third year and are projecting a growth of 158 times ( $ 190 MM ) by 2012,  with little or no distribution network. Their projections show a sustained net profit margin of 30% all along. Does that mean no R&D spend envisaged…?  What are the takeaways here for our guys…? 

The sand is shifting beneath your feet,  provide for sustained innovation,  your NPM is not 30%,  it’s going to be under 5% soon and if you don’t innovate,  get trampled by elephants and even some goats. 

Just yet,  the only question they had was “ who can fetch us the highest valuation”…?

To them I would only say this.  Please learn a thing or two about VC’s probing ways.  They invariably probe.  Do you think they can’t see you thro…?  Too bad. They are significantly well networked than you and may be, have even looked at your business even before you realized it. Had they found it compelling, they would not have waited for you to approach them.  Now that you walk down that road, do your homework and take a hard look at what you’ve got to offer.  And, for God’s sake, stop bragging about your League.  Allow them to make that out when they see your presentation.  May be that is the 14^th biz plan from that League that they are staring at for the day. ( Gimme’ a break,  let me puke ).  

You’ll get what you’re really worth.  A good negotiator will still have to go by what you got.  Nobody pays anybody for having just a name.  In fact, a good negotiator would beef your plan up by inserting de-risking strategies to steer it towards a favorable risk-reward.  And that, is going to get you better valuations.  No magic mantras here. 

Shorn of your arrogance, when you come down to earth with your feet firm and rooted,  tap me.  I’d still be around.  Then may be, we can talk deal. 

Deserve your valuation,  goddamit,  don’t demand…!