How You May be Signaling Price without Knowing It

Posted on Jan 20, 2011 | 55 comments


I was having a chat with an entrepreneur who I really like and who I try to mentor from time-to-time.  He has an interesting business and one that has a viable shot at being an innovative & profitable business.

One problem.  He’s struggling to raise money.  This is extra frustrating in an era in which all you read about is how frothy the VC / funding market is these days.  People are raising in record times and with wacky valuations.  It is not an uncommon story that this is happening but others are struggling.

Obviously the diagnosis can have many route causes:

  • Sometimes it’s a question of a market that is less sexy than the current VC fad.  That’s OK if it’s your problem as long as your business really is differentiated and compelling.  You’ll find the right investor eventually through persistence.
  • It might also be that your product isn’t complete enough, you don’t have enough evidence of success (by what ever measure is appropriate)
  • You might not have gotten access to the right pool of investors and/or need to work harder to get appropriate introductions.
  • You might just suck.  That happens, too.  Joking aside, I wish more VCs would humbly, politely and respectfully tell people when this is the case.  I know it’s strange to say, but I almost always do.  I try to be constructive.  But I tell people up front when I think the idea won’t work, the team is wrong or the strategy is off base.  Sometimes I’ll say, “I highly doubt you will get funded with this concept – here’s why …” and I try to offer constructive points. But I’m also quick to point out the obvious – I’m a single data point and might be wrong.  Mix my views into the pot and make your own mind up.
  • You might be positioning your market or the opportunity wrong.  That happens A LOT.  An otherwise interesting company & space gets reduced to, “oh, but Yelp is already doing that” or “there’s no way you can compete with Mint – they have the market locked up” when you really didn’t see them as future competitor.

Experienced people who are advising you should spot most of this and after a few failed investor meetings if you have good intuition you can problem pick up the signals yourself about what is not resonating.

But this particular guy who called me for advice I suspect had a different problem.  It was the silent killer.  The one he probably had no chance of identifying.  He was price signaling without knowing it.  His company had raised seed money already.  They had good assets and initial market traction.  But it isn’t in a tradition VC market and certainly not one perceived as “hot.”  That, and they were in the second inning on a pivot of the business – albeit with early signs of success.

I asked him, “how much are you raising?”  He said around $7 million.  They have some revenue but not much.  I asked him what his valuation expectations were and he said he wasn’t fixated on that.  He wanted a good partner, a fair valuation, and quite honestly, just some effing money!

My view is that investors in this situation start to form ideas about what the valuation would be even though you aren’t naming a price.  I say this all the time: the “sweet spot” of dilution on a normal deal is 25-33%.  If you’re hot you might be able to push this down to 15-20% depending on the investor and the competition.  If you’re SUPER hot maybe lower.  Obviously this excludes late-stage deals.  If you’re struggling a bit on funding you might see 40% dilution.  Also, if you combine 2 VCs that want 20% each you might get to 40% de facto.

So two things are at work here:

  1. Most people are assuming the valuation expectation would be between $14m pre-money ($7 raised / $21m post = 33%) and $21m pre-money ($7m / $28m = 25% dilution).  If they thought it wasn’t competitive they might think they’d get to $10-12m pre but more likely they assume $14-21m.  By stating the amount of the fund raise, you set price expectations without knowing it.
  2. Investors will say to themselves, “irrespective of how much ownership I get and what the price is, am I prepared to risk $7 million dollars at this stage of the company with the proof points I see in front of me?”

So I asked him if he really needed $7m and whether he had those price expectations.  His answer was, “no, I think I could get by on $3m and am willing to have a lower price.  I just figured since we did a large seed round people would be expecting a much larger next round or it would look strange.”

I encouraged him to raise a smaller round, get more proof points and if the business were working better raise more money later.  You do always need to tell people how much you’re raising and how long the cash will last.  So it’s not about “not naming an amount” it’s about signaling a lower price IF the situation is appropriate.

Obviously people might have passed for other reasons and I asked him to be reflective about that.  Specifically I told him if he could bridge himself to get further down the track on his pivot it will feel less like a ‘Tweener company (between one stage and the next).

I’ve seen this guy present.  He does a good job.  I know his market – while not “hot” it’s real.  I know that it will resonate with some investors.  I know the guys he’s talking to and they’re some of the right people.  But they’re telling him, “not now, we want to see more progress.”  I’m sure that’s accurate.  But I also know that the amount of traction you expect as an investor is tied to both the amount of money being raised and the price you’re paying.  That’s risk vs. reward.

So just be aware that while there are many factors that go into price expectations (serial vs. first time entrepreneur, perceived competitiveness of deal, data showing traction, etc.) many investors will make their assumptions about your price even when you haven’t told them.  Ask for the appropriate amount of capital relative to your progress.  If the first few meetings aren’t going to plan, consider “A/B testing” a different raise amount (with a changed financial model) at a couple of VCs to see if that changes reactions.

When you’re raising money and it isn’t coming together it totally bites.  I’ve been there.  You feel like you’re groveling – never fun.  But please be very self reflective on all reasons why the funding isn’t coming together.  Seek feedback from many sources.  Think critically about how you might be perceived.  Ask for feedback even when you don’t get it.  Be open to it and not argumentative or debate the points that “they didn’t understand.”

And be careful about inadvertently signaling your price too high.

  • Adrian Meli

    Mark, I like the idea of the honest feedback. It is a fine line though I am sure in the VC business because if you try to convince an entrepreneur that his or her idea won't work AND that entrepreneur is very good/talented you will likely not have success in convincing them. I am sure it is interesting to watch how different people respond to the feedback, so I was curious if you use the feedback as a mechanism to see how potential candidates respond to some negativity, etc. – Adrian Meli

  • http://www.opusomni.com Bethannwright

    Hi Danny,

    I enjoyed visiting your website. My ten year old son has an electric guitar and an electric bass guitar.
    You actually have a much bigger market to potentially tap than you realize, and a team with the skills to do it–cognitive psychology, HCI, UI, Coding! (you just need a little horizontal integration-please send me a quick note if you like, and I will share some thoughts). Good scientific evidence supports that children who engage in playing at least one musical instrument (the earlier, the better) score substantially higher on standardized assessments, etc. How about redefining your market as the parents of children in pre-kindergarten through 12th grade and those children?
    Beth

  • http://tonepedia.com/blog Danny Strelitz

    Hi Beth,
    Thanks for the kind words :) I would love some feedback, so you can get me at danny (at) tonepedia.com
    The site you visited is an old alpha from about a year and a half ago, done with about 5000$. We are now set with a new team, and our platform is on the final stages of development and is soon to go out to the crowds.
    I hope your son liked it and enjoyed the different sounds we got from our community.
    As for defining the market – your view is very interesting, and we will give it some thought.

  • http://www.opusomni.com Beth

    Thank you for your kind note, Danny. I am so happy to reply. I have written to you directly at your email address above.
    Best, Beth

  • Ritesh

    Mark, Amazing post. Exactly what I was looking for. feel like almost going through me – inside out. lol. But actually helped me to decide rather to make my e commerce portal self funded or not. however, still looking forward for your expert opinion. Please have a look at it and advise.
    Ritesh
    http://www.letsshop.in