FIND THE MINIMUM VALUATION METRIC THAT SATIFIES THE INVESTOR ROI.
The real issue is……can you manage a shareholder private equity company? Maybe, a pre-cursor is….Can you sell your companies “securities” to investors who wrote the book on placements and this is your “first” attempt? These are not good odds. Given, if you are not a class A founder with team and a value proposition to die for, you will never get this far. So, let’s assume you have all the right stuff and have earned your way into a first meeting with a potential experienced investor. Can you manage shareholders?
#1. Know before or don’t be afraid to qualify Investors. Ask potential investors about their investment “Sweet-Spot’ and ROI expectations. That should be your first and maybe last question. You should know immediately – if you hit or miss. If miss, by how much?
#2 Reverse engineer your Investor Strategy backwards starting with hitting ROI Requirements for Series B (10%-15%), Series A (15%-20%) and pre-revenue early stage/seed (20%-30%) round returns. Today, company valuations are based on Revenue, EBITDA and Member multiples. Members represent a new valuation metric. The challenge is to identify the MINIMUM of each to yield your investor returns. If you are asking them for their money, your investor commitment must be foremost in your mind. That is the Investor-centric approach and the discussion topic at each board meeting is…”Where are we with regard to hitting our numbers/metrics and the resulting impact on Investor ROI?”
#3. Your investor commitment is NOT your sales and business operational commitment. The business goals are based on the operational budget pro-forma’s, that should exceed investor yields – which is a good thing. Even better, when underperformed (as often the case) this shortfall should or may not impact investor commitments.
The difference shows your stakeholders that you are conservative, that you have a game plan to not only hit your ROI commitment to shareholders, but that you have also targeted an upside. You are under committing and over performing. That is smart management. A board free of strive, makes for a happy life.
Today, if you get that far, investors take your sales, EBITDA and/or Member forecasts and/or Valuation multiples and reduce them by a margin of error (i.e. 50%) and then plug in their ROI measure risk and upside yields. You may not like the results, So why is this buyer (investor) driven? Because entrepreneurs don’t understand the drill!
Five years is a short timeframe in entrepreneurial years. Capital and its shortfall is the number one reason for missing milestones. There are no excuses for dilution. Dilution is just poor planning. Yes, 90% comes from revenue shortfall which is code for poor forecasting and channel sales execution. Investors are also not buying more capital to address new markets, if your underperforming in your current channels. You want PIVOT where?
A month or so, a Partner submitted a Future Star (pre-revenue) for Innovation Stars with an excellent value prop, experienced team, significant founder investment, seeking a bridge to complete Beta, recognizing Beta was a requirement to raise a Series A round.
The business was a unique niche in the social media market and valuation was correctly based on membership. The team’s sales research validated that by closing three or four majors they would attract their followers on a Free-imum bais exceeding 30 million members. At the recent Snap Chat selling rate > $300/member the valuation exceeded $9B and therefore, a no-brainer for investors. Game-Set-Match. Returns off the chart. What could go wrong – even with a 50% error rate?
The answer from an investor perspective is….”everything.” They stopped investing in “Home Runs” in circa 2002.
The Financial Reverse Engineering solution, from the investor perspective, is to identify the MINIMUN number of members it takes to meet the bridge/seed round investors, the Series A and down round Series B investors.
Turns out that number is more like 8 Million members at $50/share. This should be the investor plan. It does not change the operation plan to close the three majors and see what their loyal followers adoptions will yield. However, the minute the member adoption reaches 8 Million (no small feat) and if the current member valuation is $50/member or higher – the investor/s will ALL realize their returns. Everything else is upside! If the member activation benchmark is made in year 3 or 4 then.. it is all up-side and made an earlier exit. If the member valuation multiple, based on current member community exits is higher than $50/member – it is more up-side
So, plan for the absolute worst case for key metrics (Revenue, Members & EBITDA) to achieve Investor ROI to include down rounds of capital. Then, if you hit your operational numbers, or miss a little, you will still be a big hero because you exceeded your shareholder ROI. It may also mean you don’t need, or can defer, planned down-round capital. Both represent an investor WIN-WIN. Deferring down round capital means you have more operational achievement that supports a higher down-round ask. So much smarter than “shooting for the moon” with your operational plan and stakeholder expectation, then suffering the consequences of the catastrophic dilution re-wind.
Making Angel investing GREAT AGAIN. Larry