How Do I Maximize Valuation?
One of the most frequent questions we get from entrepreneurs is, “What is my company worth?” Our response is generally: “Exactly what someone’s willing to pay for it.”
Entrepreneurs often fixate on obtaining a lofty valuation for their company after hearing about a competitor’s stratospheric exit. In my experience, recent transactions are one factor that can help determine a company’s value, but not the primary factor. In the technology world, it’s not always easy to get an ‘apples-to-apples’ comparison between companies. Bankers and other advisors often add fuel to the fire by pushing entrepreneurs to take advantage of ‘frothy’ market conditions.
Rather than anchoring expectations on a recent transaction in the market, we advise entrepreneurs to take a more thoughtful approach to liquidity. Below are frequent questions that entrepreneurs ask when thinking about liquidity, and a sample of the answers we give.
Should I explore the market now, or wait until next year when my company is bigger and worth more?
The answer depends on three factors:
1. The percentage of your net worth tied up in the company – think diversification.
2. The market dynamics of the space the company is in – think recent transactions.
3. The current and future growth profile of the company.
Nearly all entrepreneurs feel like their company will continue to grow quickly, yet even the best growth stories taper off eventually. Selling at the steep point of the growth curve generally achieves the highest valuation, and we recommend selling into positive news and strong growth. As soon as the growth rate slows, the valuation of a company descends precipitously.
Should I do the transaction myself or work with an advisor?
Students in my negotiation course at Stanford often come with boastful stories of their successful negotiations with car dealers. As you can imagine, I don’t often pity the car dealers after listening to the students’ stories, knowing full well that they made out just fine, no matter what my students may assume.
Similarly, entrepreneurs are rarely in a position to optimize negotiations with investors or buyers who, like the car dealers, generally have the upper hand in terms of knowledge and transactional experience. Since private company valuations are subjective, it makes sense to find the best negotiator to represent you in a transaction. Additionally, it’s usually difficult for entrepreneurs to push aggressively on their own behalf for fear of damaging the relationship with their future partner.
How will I know if the valuation I’m offered is fair?
The only way to know if you have optimized the terms of your transaction is to run a full process. This means speaking with a broad variety of investors or buyers and testing the market thoroughly. There’s nothing more powerful than leverage in negotiation, and the best leverage is to have multiple parties at the table.
Entrepreneurs often get caught up in the attention they receive from investors who proactively reach out to them. While it’s nice to get a call from someone with money to invest, entrepreneurs should realize that some of these investment firms will talk to any private company on the planet, and a small percentage of these calls ever result in a liquidity event for the entrepreneur. Rather than react to inbound interest, it’s better for entrepreneurs to take a forward thinking approach, and define the timing of the process for their transaction.
The Bottom Line
If you are an entrepreneur hoping to maximize your company’s valuation, you should:
• Take a proactive, not reactive, approach to assessing liquidity options
• Run a strategic transaction process that creates strong competitive tension
• Hire the best advisor you can find to negotiate on your behalf