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Updated September 15, 2023You’re reading an excerpt of The Holloway Guide to Raising Venture Capital, a book by Andy Sparks and over 55 other contributors. A current and comprehensive resource for entrepreneurs, with technical detail, practical knowledge, real-world scenarios, and pitfalls to avoid. Purchase the book to support the author and the ad-free Holloway reading experience. You get instant digital access, over 770 links and references, commentary and future updates, and a high-quality PDF download.
This term will include the price per share the investor will be paying, and the valuation the price is based on. We discussed the interplay between price, valuation, and dilution of ownership in Determining How Much to Raise.
important You may receive a term sheet with price per share blank. You and the investors are negotiating a valuation, and once that amount has been agreed upon, your lawyer will do the math to determine the price per share.
danger It’s common for VCs to just say “valuation” in an offer without specifying whether they mean pre-money or post-money valuation. For example, “I’ll write you a check for $5M at a $20M valuation.” But there is a big difference between a $20M pre-money valuation and a $20M post-money valuation. As a founder, it’s critical to be aware whether you’re discussing pre-money or post-money valuation, so speak up and make sure both sides are clear.
Practically, when negotiating this term you need to communicate with your investors about the following:
Percentage of the company you’re selling (20%).
Amount that you’re raising (when you’re backing into a valuation, you’re thinking of selling 20% for $10M, because you need $10M to reach a set of milestones before you raise again. The investor may say that they want to give you $10M for 25%. If you have no other deals or you really want to work with this investor, you say OK.
Whether the valuation is pre-money or post-money.
If you’re raising on a convertible, you will have a separate term for the valuation cap and should discuss whether it is on a pre-money or post-money valuation.
Depending on how much you communicated with investors in earlier investor meetings, you might go into term sheet negotiations knowing what valuation to expect, or you might go in ready for a serious conversation.
important Most founders aren’t going to be choosing between different valuations on multiple term sheets from top-tier firms. If you are, congratulations. But most of you will be choosing between one term sheet and shutting your company down, or between one term sheet from a great fund and a term sheet from a mediocre fund. Aim for the right valuation, not the highest. High valuations give more space to fall short, which has consequences for future fundraising and can lead your investors to look for an exit strategy that is not in your best interest. You may even consider compromising on valuation for a higher caliber VC firm; or, in the same vein, offering a premium investor a lower price (more equity for less money). Keep in mind a minimum valuation and a lower price you’ll accept without further negotiation, but don’t share those numbers.
For more information on picking a valuation, visit Determining How Much to Raise.
You may see “liquidation preference” as a term in your term sheet, “liquidation rights,” or simply “liquidation.” This is a big one.
Liquidation preference means that preferred shareholders get paid before anyone else. You’ll often see preference expressed as “a 1X liquidation preference,” where the 1X refers to the multiple—that is, a return of the original investment amount. We discuss preference in detail in Choosing a Financing Structure.
Practically, founders will need to be able to explain liquidation preference when speaking with new investors inquiring as to how much money has been raised to date. Additionally, most seasoned executives will ask about liquidation preference when joining to get an idea of how much the company would have to sell for in order for them to make any money off any stock you offer them.