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8.4 Arriving at a PriceThe market will determine the price. By now you've determined the value, or range of values, that you think is fair and accurate for the worth of your business. And in preparing for negotiations, you've established what you're prepared to give up to the investor in exchange for the investment. But though you may think you know the value of your business, the actual price will only be established as you negotiate offers with investors. Consider how you will present your price; you want it to appear reasonable and based on proper analysis. Think about when to present the price; it's an important part of your negotiating strategy. Be sure you assess the offers you get fairly, comparing apples to apples, and don't forget to consider non-financial issues. If you're having trouble arriving at a price, there are mechanisms for bridging the price gap. Investor's PriceEach potential investor will have a different valuation, based on his or her perception of future risks and opportunities. In general, the more knowledge the investor has about your business, the less uncertainty he or she will feel, possibly lowering the price. A variety of factors can affect the investor's valuations, including his or her:
![]() How to Present Your PriceShow That Your Price Is ReasonableWhen you disclose your asking price, you must be able to support the price in a rational and convincing manner. Usually it's best not to share your detailed calculations. Instead, provide investors with summary value calculations, a description of the valuation methodology adopted, and the key considerations and assumptions you made in arriving at the value of your company. It may be useful to provide the investor with a summary of alternative calculations that indicate the sensitivity of your conclusions to changes in key variables and assumptions. And if you find information related to transactions involving potentially comparable companies that supports your value determination, summarize this information for the investors, too. Work to Lower the Perceived RiskGenerally, anything that lowers the perceived risk to the investor will increase the value of your business and decrease your cost of getting funds. It's important to remember these two points:
![]() When to Present PriceThe best time to disclose your price may vary depending on the type of investor you are approaching.
Assessing OffersConvert All Offers Into Their Cash EquivalencyIn most cases you can expect to receive cash in exchange for a percentage of the common share equity of your company. Some investors, however, may propose instruments other than simple common share equity. In considering these, convert them to their cash equivalency (the equivalent amount of cash received today). Non-cash components of offers can include:
Don't Forget Non-Tangible AspectsWhen you compare the offers you receive, don't overlook important considerations that may not come with a price tag. For example, will the investor bring other benefits, such as management expertise, business contacts, other business opportunities, and the opportunity for further investment to your company? Will you be comfortable dealing with this person? Ways to Bridge the Pricing GapReaching agreement on price can be very difficult, but there are ways to bridge the gap. One common method is a ratchet clause. The underlying principle of a ratchet clause is that the entrepreneur will earn back a percentage of equity if certain targets are met and, likewise, will give up additional equity if targets are missed.
When establishing the components of a ratchet clause, ensure that the
target is objective and measurable. Also establish whether the calculation
will be affected by unusual income or expense items that may occur over
the measurement period. Due to potential tax consequences and the sophistication
of this type of financing structure, you should seek professional advice
if you're going to include a ratchet clause in your financing agreement. |
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Updated: 2005/07/12![]() |
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