When its smart to take a LOWER valuation

May 13, 2011 § Leave a comment

A friend of mine recently raised a second round from insiders. No new money. I knew he had strong demand from new investors, so I was curious why he didn’t take fresh money to set valuation. When I inquired he told me something that blew me away – he also took this round’s money at a significant discount to what outsiders valued the business.  What?!?  You turned down a significantly better value at basically the same terms?  My response was, “I am really intrigued to understand why.”

His answer changed me from “that’s crazy” to “that was really friggin smart.” Here were his reasons:
1. Taking insider money at a discount allowed him to keep exit flexibility. Meaning the exit value he needed to provide a great return for his investors was much lower. Current investors were averaging up, but still had a basis significantly lower than fresh money. He is in a highly competitive, fast growing industry. Who knows what the future will hold?  So he kept complete flexibility to hit “eject” when he feels the market is right.
2. He didn’t have to give up a board seat.
3. Speed. No doc negotiation. No management distraction. No hassle. Just get it done and keep focus on the business.

So there you have it. I am convinced he made the right decision. How about you?


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