From my family to yours…

Starring Bob Mendelson, Jessica Mendelson, Paul Mendelson, Sydney the Dog and Sammie the Cat.  Conspicuously absent is yours truly.  Call it creative license.

I regularly get questions concerning how venture capitalists value companies.  In fact, there seems to be an increase in the frequency of this question to me personally and through AskTheVC. 

It’s not an exact science.  On top of that, there isn’t a broad enough market to come anywhere near a public pricing mechanism.  (Insert joke about current public market chaos here).  VCs typically take into account many factors when deciding how to value a potential investment.  You’ll note that few of them are quantifiable into hard numbers and at the end of the day, the VC and company must agree on an exact number in order to get a deal done.  So what are some of the factors?  In no particular order, I present the following:

1. How mature the company is

What stage is the company?  Early?  Late?  Pre or post product release?  Customers?  Pre or Post Revenue?  Other major milestones?  Hopefully it’s clear that the later stage company (if all goes well), the higher the valuation. 

2. How much competition there is with other potential funding sources

More is better.  If I feel like I’m competing with other VC term sheets, then the valuation will likely be higher.  I would offer caution to not overplay this card unless you truly have another interested party.  I’ve seen this situation a number of times where the company overplays its hand and doesn’t get their fundraising done and loses face in the process.

3. Quality of the management team

With a great management team, risk is taken out of the equation.  In fact, many VCs believe (me included) that even the best idea fails without an excellent team.  The more this quality team is built out before financing, the higher potential valuation you might get. 

4. How the valuation plays into a particular VC’s investment thesis

If a VC is an early-stage investor, they’ll be used to lower valuations than someone who invests in later stage deals.  This bias will have a large effect on the process.  I’ve seen companies that have received term sheets from both types of investors at the same time with wildly different prices. 

5. How much the VC thinks the company in particular wants that VC

VCs bring much more to the table than money (hopefully).  If a company wants a particular VC to fund their company (either because of domain-specific knowledge, prestige, nice offices, etc.) the price for that particular VC may be lower than others. 

6. Numbers, numbers, numbers

Yes, the numbers matter too.  Whether it is past performance or predictions of the future, these all play in.  Revenue, EBITDA, headcount, etc. all factor highly into the process.  That being said (at least for early-stage companies) don’t believe everything your MBA professor told you about DCF and other financial analysis.  Especially at the early stage, the only thing that I know about your financials is that they are very wrong.  So the financials have limited applicability to hard number crunching but are very telling of how the management is thinking about their business. 

7. How big the market is

This one is pretty self explanatory.  Bigger equals better for valuation.

8. Potential acquirers

Again, this should be easy to understand.  If there are many natural acquirers for your company, this only helps in the valuation discussions. 

9. Competition

Valuations received by your competitors can potentially make a case for you receiving a similar valuation or at least have a small "market" to compare your company performance to.  This argument is of different importance depending on who your VC is.  Some care a lot about competitive metrics and some don’t value them at all. 

10. Current economic climate

Bad climates normally lower valuations.  It seems to effect later stage fundraising valuations more than early-stage transactions. 

11. Previous deals

A particular VC’s experiences and biases will have a large effect on valuations they will present you.  Part of a VC’s job is to be good at pattern recognition.

12.  Other

There are other things as well, including the tried and true "I know it when I see it" analogy.  Part of all of these exercises are truly black box. 

Please note that I cannot give specific advice to folks on how much their company may or may not be worth.  I only know one thing about attempting this exercise – I would be wrong.  And you would not be happy with me.

It takes our group many meetings, much diligence and market analysis in order for us to arrive at the valuations we offer potential portfolio companies and even this is not an exact science.  For me to attempt this exercise for a company that I am not deeply involved with would be futile.

At the end of the day, it’s all about getting a transaction completed and whatever that number ends up being, is a rough approximation of what the company might actually be worth at that point in time. 

Or maybe it’s completely irrelevant.    But at least you got funded.  Good luck out there.

(I feel like I could write an entire series of posts on the subject, but I think that would inject too much false precision to the discussion. Again, the majority of the factors are not easily quantifiable If you just can’t help yourself and need to see numbers, check out the Dow Jones report to see some GENERAL guidelines. You can buy the whole report here.)

Ever since I posted my original rant about the over lawyering and overcharging by certain attorneys in the startup ecosystem, I’ve become synonymous with legal fees apparently.

It isn’t all bad.  Our companies are being charged less, lawyers seem a little more likely to negotiate higher bills when the realize I’ll blog about them if they aren’t reasonable and it appears that we’ll have a new investment to announce shortly related to my Law Firm 2.0 series.  (Keep your fingers crossed).

So I guess that I shouldn’t be surprised how many times the same article was emailed to me this week.  According to Law.com, Legal fees continue to rise despite the current economic times and in one case have exceeded $1200 an hour!!!! (White & Case.  Boo.)

The average law firm raised their rates by 4.3%.  Anyone else out there get a raise that big this year?

I’ll take a stand and say this is ridiculous.  I’ve never met a lawyer worth this much per hour.  I might consider one exception for a certain litigator that I know who is incredibly awesome and so efficient with his time that his hourly rate is somewhat irrelevant, but I only know potentially one person in the thousand lawyers that I’ve worked with. 

Shame on you folks.  It won’t last.  Mark my words.  Viva La Law Firm 2.0…

I generally dislike holiday card season.  I get dozens of cards that all basically look the same.  They’re bad for the environment and are a bad use of company funds because nobody remembers anything about them or who they’re from.  I did, however, get a great card this year from one of the companies I advise. 

Shareholder Representative Services sent a card that is awesome.  It’s both timely and funny.  I never thought I’d enjoy seeing George Washington sing, but I did.

Go to www.shareholderrep.com/srsecard to check it out. If you’re going to do a card, make it interesting and memorable.  SRS is doing a lot of excellent work besides holiday cards.  Check out their website.

Great job guys.  Happy Holidays everyone.

If you haven’t seen it yet, Coldplay has been sued by Joe Satriani over Cold Play’s hit song Viva La Vida.  Joe is claiming that his song was ripped off.  I think the following video best explains the lawsuit. 

It’s really uncanny how similar the songs are.  They are even the same key.  But is it copyright infringement?  I love lawsuits like these because there are such interesting issues at play.  My former law school professor Susan Kornfield is to thank for creating all of my interest in this subject.

The key here is that Joe must prove Coldplay ACTUALLY copied his work.  George Harrison was found guilty of plagiarizing "He’s so Fine" when he released "My Sweet Lord" when the court found that he subconsciously copied the song.  He’s so Fine was a big enough hit that it was hard for George to argue that he had never heard the song and although he contended there was no intent, the court said that subconscious infringement was still infringement. 

Let’s assume for a moment that Coldplay did not intentionally steal Joe’s song.  (And if they did, they were idiots – couldn’t you guys at least change the key?).

The question is did they have access to hear Joe’s original work?  Joe’s song certainly never got any airplay.  Even my rock and roll guitar partner Ryan had never heard of it.  This will be very interesting to see how it plays out.  The chord structure is nothing novel, it’s really all about the melody.

If you like interesting cases like this, make sure to check out John Fogerty being sued for allegedly copying himself and Ray Parker Jr. having to pay Huey Lewis for Ghostbusters.