Founders, do not worry about the price, worry about having leverage

Often times, when founders are starting to raise capital they ask me what will the likely price be.I tell them this an irrelevant question, and they get very surprised. But Alex, they say, pre-money valuation is so important to me  - I want to get the best price ?

While this is indeed an important question there is a right time and the wrong time to think about it.

The question of price is irrelevant in the beginning of the capital raising process.

Also, pre-money is a wrong way to look the actual price, because the price is actually based on post-money valuation.

Pre-money valuation and price are irrelevant in the beginning of the capital raising process, because we don’t even know if the financing will come together. We don’t even know who is interested, we do not know if  there be multiple bidders, etc.

In the beginning of the capital raise process, we don’t have any information that actually help. set the price.

So what should founders worry about at the start of their financing ? In a word - leverage.

Whoever has the leverage will ultimately control the price.

Here is the simplest way to understand it - if the investor knows he/she is the only one at the table, and you need capital, then the investor has leverage.

If you can’t walk away, if the deal is not competitive, if you have only one option then you do not have any leverage, and therefore you aren’t going to get the best price.

The real question founders should focus on at the beginning and really before financing is how to create leverage ?

An early stage company has really only two levers for creating leverage - profitability and competitive round dynamics.

Most startups companies aren’t profitable, and need to raise capital. If you are actually profitable then you have leverage. You can walk away from the deal you don’t like.

Otherwise the only way you have leverage is by having a competitive process. If multiple investors are bidding you have leverage, and can drive the price up.

What’s the best way to create a competitive financing ? Strong Revenue or User Growth.

If you are crushing it, and growing the business, then many investors would want to invest.

This is why we tell the founders - focus on the business, grow the business and financing will likely take care of itself.

Another way to create a competitive process is to pitch really well, and line up multiple investors at the finish line. If you get a term sheet, and then get another term sheet, you can likely improve the price by revealing that there are multiple interested parties.

The take away is - in the beginning of the capital raise, it is pointless to worry about price. But if you think through how you get leverage, depending your specific situation, you may end up with a better ownership outcome.