Let’s delve deeper into a few important pointers with respect to this issue:
VCs see no correlation between angel and VC valuations
Angel investors, particularly those related or known to founders, tend to negotiate valuations across the table, rather than based on any sophisticated techniques. This is justified, given that they are often backing paper plans. On the other hand, VCs are managing institutional capital and therefore, implement rigorous due diligence to estimate the risks and 5-6 year returns potential of a business. Based on this, they come up with a valuation that they can justify to their Investment Committees.
As VCs have much more information to play with and spend much more time doing diligence on opportunities, they make decisions that are independent of the valuation benchmarks set by angels. Founder need to appreciate that angel valuations aren’t a realistic lever while negotiating with institutional investors.
Quantum of capital invested is extremely relevant
At angel investment ticket sizes, valuation sensitivities are less on both sides and therefore, the mutually agreed-upon numbers often do not reflect the correct price of the asset. Correlating these numbers with valuation proposed by a VC looking to invest $5 Million in the business often doesn’t hold fort.
Impact of market conditions on VC valuations is much more compared to angels
As institutional investors answering to global Limited Partners and also worrying about the risk of raising future rounds of capital in the proposed venture, VCs would tend to remain much tighter on valuations when macroeconomic conditions are bad. However, the same would have minimal impact on angel valuations – an important point to keep in mind while negotiating.
Diluting too much in angel rounds can be potential VC deal-breakers
Often, founders dilute too much in angel rounds and are therefore, driven to expect higher valuations from VCs to control dilution. As VCs want founders to have enough skin-in-the-game at the end of 3-4 potential fundraising rounds by the company, this issue becomes a frequent deal-breaker.
Entrepreneurs are encouraged to negotiate valuations hard with VCs. However, angel valuations wouldn’t be the right benchmark while they decide their reservation prices and alternatives. Positive negotiation levers would be revenue growth, margin improvements, prevailing multiples, exit valuations etc.
Read more articles from Soumitra Sharma.