So what is the right value for raising institutional (venture) capital?
As with many things, beauty is in the eye of the beholder, or in our case, value is in the wallet of the investor. Whatever the market will bear is the real value of the company. This value may and will have nothing to do with the value your angel investors paid for their stock. It will have absolutely nothing to do with the amount of work you and your team put into making your product or putting together your offering. And it certainly bears no relationship to how much the company would have to be valued so that you retain control.
Rather than focusing on the paper value of their current ownership, founders should think ahead, through as many of the "gates" as they can forecast, that stand between them and commercial success (all the way to a liquidity event). It's like a marathon, as opposed to a sprint. The leader at the mid point is not necessarily indicative of the winner at the finish line. Not all money is created equal. It may be more important to get a good value, rather than the best value, from a partner who is in it for the long haul. This may mean taking a lower valuation today in return for accelerated market entry and mind share from a partner who brings much more than just capital to the equation.
Often we see founders falling prey to early angel investors "bidding up" the value of their companies during several cash calls in an effort to increase their short term valuations. While this may "feel good" at the moment, it could become a critical obstacle to their long term success. Founders should understand that it will be VERY DIFFICULT to later get an early investor to digest a crammed down valuation if these angel values were artificially inflated.
Here's an example: A plastics company in upstate NY purchases some very interesting patents from a large industrial conglomerate who doesn't view them as critical. They raise angel capital to begin to prototype this product. They run out of cash. Management either knew or should have known they would need more cash. They go back to their investors needing more capital. The investors agree, perhaps they bring in a few of their friends in this round, but only at a newly established higher value. This continues for several more years. By this time the company has yet to commercialize its product, yet the valuation is now in the double digit millions - based almost entirely upon the angel investors bidding against themselves to increase the value and to feel good that their investment is increasing in value. Has this higher valuation helped them?
They are now getting closer to being able to commercialize the product. They need sales and marketing funding, they need production facilities, they are ready for their launch. This requires capital in excess of anything they have raised in the past. So they seek out institutional investors. In fact as they become a bit more desperate, they also seek a strategic buyer. There are several interested acquirors - but they each in turn demur due to the demanded valuations. Ultimately there is interest from institutional investors (bigger fool theory in play here?), they can't justify the lofty valuations the angels' fictions have created! But the company needs the capital. And voila - cram down occurs. Founders get squeezed (out completely in this case). Early investors get burned. Later investors get fried! And company's prospects for success are still in doubt. But the founders felt great at these lofty values, that is at least until ... they got dumped!
What could have happened?
With some foresight, the founders might have begun to understand that the only real valuation that matters is the one just before they cash out. Restricting their fund raising rounds to smaller increases (or sideways) in value that were commensurate with their market progress, might have enabled them to keep the valuations in line and then be able to raise capital from institutions at an appropriate rate. Or, it might have enabled them to cash out in a sale to a competitor at a valuation they could stomach.
This vortex of capital raising can stymie the progress of even the most promising venture. So beware when you hear yourself remarking about how the world doesn't get your value proposition! The "best" valuation you can have for your company, may not be the one that momentarily makes you currently feel the richest.