How to Discuss Business Valuations with Investors (in The Right Moment

One of my clients was constantly getting 'friend zoned' by investors.

I recently worked with a cool company that was frustrated by a recurring pattern during their pitch meetings. They would impress investors with nods and smiles, only to hear, “That’s very interesting, we’ll be in touch.” Repeatedly, this left them wondering what they were doing wrong.

After reviewing their pitch deck, I immediately spotted the critical error that was stalling their investment process. From the first glance, it was clear why progress wasn’t being made: they had included their desired valuation in writing in their deck.

Although their valuation numbers were within market ranges and supported by benchmarks they could defend, revealing this number too early was a major misstep. During the long and draw out investment process its very important that you leave detailed financial negotiations for the right moment.

Including your ideal valuation in your deck is like sending a racy picture on a first date—it’s way too early and can be a major turn off. It’s also akin to discussing marriage timelines on a first date: too much, too soon. Given that investment is a lengthy process, you need to pull an investor through each step gradually.

When is the right time to discuss business valuations?

So here at the Funding Guide, we talk about there being a 10 step investment process. Whilst not every investment process follows this exact method, many do.

In our opinion, you should not be having this conversation until after step 6 in the process - which is after the pitch, after the follow ups, after the information requests, and after you have been told specifically that the investor is moving to the term sheet stage. You should only be having the valuation conversation right before a term sheet is drafted. And you should definitely be having the conversation... do not let them exclusively decide on your value and send it to you in the term sheet. Be an active participant in agreeing value.

Why Business Valuation Shouldn’t Appear Early

When discussing business valuations with Australian investors in particular, or broaching any valuation-related topic, timing is everything. In the early stages of an investment process, your focus should be on what excites investors about your business—not on valuation. The more excited investors are when the time comes to discuss valuation, the more open they will be to you stating your case for a fair number.

A comprehensive valuation database should be prepared and shared at the appropriate stage to provide a detailed assessment of your business’s worth. Compiling a database of 'comps' or comparative values of businesses that have raised capital or traded at valuations similar to your ask, can be the most compelling way to justify your ask. But this should come well down the line when you have already gingerly discussed the topic.

We talk extensively about how to value your business and set your expectations correctly in our eBook 'How to Value your Business in 2024'.

How to Avoid Valuation Discussions at Early Stages

Avoid discussing valuation until you’re ready to draft a term sheet. For at least the first 6 stages of the investment process, dodging this question is paramount.

If an investor asks about valuation early on, you might say:

“We have some ideas and benchmarks, and we’re open to that conversation when the time comes. Right now, we’re focused on finding the right investment partner to grow this business.”
Alternatively, reference your shareholders’ expectations by saying, “Our current investors paid a certain multiple in the last round, which reflects their appraisal of our value. Based on our progress, they would expect something similar—or even better—in this round.”

These responses subtly defer the conversation about valuation without committing you to a fixed number. In many of my investment discussions, the topic of valuation wasn’t raised until the sixth or seventh meeting. When it finally comes up, be careful about your positioning and always demonstrate a willingness to hear the investors appraisal on the topic. Holding a fixed view on your valuation may cause you to pass up investors who could be a strong match for your business.

How a Valuation Conversation Should Unfold

So the day is here and it's time for you to discuss valuation.

Start by asking the investor how they are seeing values at present - where is the market at? This ensures you are contextualising the conversation within the market environment.
Ask the investor what their target return and target timeframe is for realising value of this investment. If they share a high rate of return over the short period (10x over 3 years) then this means their need to get this investment at very low value, to increase their likelihood of hitting their target. An investor needing a high return over a short period is a red flag for value. Investors with long time horizons and lower returns is usually a green flag for a fair value conversation.
You need to understand how they intend to get return out of the investment over time. Do they want cash dividends from profit? Or are they happy to forgo dividends for value uplift over time? If they want cash returns, and you spin off good cash, then this can improve valuation considerations. If they want a high value outcome at the point of sale, and you're in a sector with high value comps overall (like AI, for example) then this can lead to a better value conversation. You ask all of these questions to better understand their motivations in investing in you, allowing you to have meatier responses to anything they throw across the table.
Ask the investor which other funds or investors they are most closely aligned with? Do they have a fund or other investor that they often come up against in deals. This is a subtle way of you reminding them they have competition for good deals, as well as giving you another data point to argue fair value in the case where their competition is paying different/better values for companies than they are.
Once it's your turn to talk, discuss your capital raising history (although this might have already come up in some of the information supplied prior). Discuss how valuation was arrived at in previous rounds, and what the justifications and elements were. These elements are usually revenue, revenue growth, profit, margin, profit growth and market size. These are the primary factors feeding into multiples, so discuss how you balanced these topics in previous rounds and how your current investors weighed up these factors in agreeing to previous valuations.
Then, you tell them that you prepared a comprehensive database of comps. Show how you deeply researched what the public and private markets are currently paying for businesses that are similar to yours across the spectrum. A comps database is one of the most compelling aspects of your argument around value. Its almost impossible to argue against a comps database - except maybe for points around whether the businesses truly compare to yours. Take an average of all the comps, and share that average.
Once you've shared the average the market is paying for the comps (let's say 4X revenue for arguments sake), then you need to mount your argument for why you think your value should be higher that the average. Point to the elements of your business that indicate you are doing better than the average. Point to companies or deals in the comps database that are better than average and compare to yours. Usually, this means pointing to better revenue growth, profit growth, margin, market size, market penetration metrics than the averages.
They will argue back, and point the things out that make you look below the average. This is them negotiating with you around the average, which is a great place to start.
Never negotiate value in the first person. You are there as a representative of your entire shareholder base, and you cannot speak for them, or discuss their opinions with investors without a mandate. Never share your personal thoughts on any topics. Act as an agent for your shareholders and never let them know what you think - because then they know their job is to just to convince you, so you will convince your shareholders. Whatever they level at you, you should constantly hide behind tropes like "well, I will have to take that back to shareholders because I cannot speak for them". Or "I don't know how well our shareholders will take that, given X, Y, Z factor". Or "I will have to run that up the flagpole and see what the response is".
It is unlikely you will reach agreement on value in a valuation conversation and that shouldn't be your aim anyway. You will reach consensus on value during rounds of revisions on your term sheet. The purpose of the above valuation conversation is to put you both in the ball park, but also to demonstrate you are well researched and pragmatic about the topic. You need investors to know you are smart, prepared and practical about this subject. After that you both go back to your offices and nut out the final number using the term sheet revision process.
The term sheet revision process is helpful in refining the number and terms down to brass tacks, and because you have to get your Board, lawyers and shareholders to review the numbers, there are a myriad of people you can reference and blame to negotiate a better deal. Value is only one element, and there can be other commercial and legal elements of the deal that can materially change the quality of the investment. You need to be mindful of all of these elements. Value is just one element of this.
Its really important that as you negotiate the terms in the term sheet, you do not attempt to change those commercial elements after the term sheet is agreed. This is considered as a bad faith act, and can sour the investment process quickly. Ensure that you get your shareholders and board's confirmed agreement on the commercial elements before you sign the term sheet, so that post term sheet matters are only small legal tweaks.

Hot Tips on Discussing Business Valuation Methods

Never put your valuation in writing or include it in your deck.
Always have the discussion face-to-face. This is one of the most sensitive topics, and it’s best handled in person where you can read everyone’s reactions.
Prepare a list of comparable transactions (comps). Do your research and be ready to share this information after the discussion.
Never agree to a valuation on the spot. Always say you’ll take the proposal back to your board or shareholders for further discussion.
Keep your emotions in check. When presented with a number, simply say you’ll consider it without showing any strong reaction.

By deferring the discussion of valuation until you’ve piqued investor interest and built trust, you create a more engaging and effective pitch process. This approach not only preserves your negotiating power but also ensures that your business is presented in the best light possible.