Steps to Growth Capital Self-Study GuideStep 8

8.4 Arriving at a 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 Price

Each 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:

• level of knowledge of your company's strengths and weaknesses;
  
• industry knowledge;
  
• perception of your management team;
  
• expected rate of return;
  
• negotiating strength; and
  
• availability of other investment opportunities.

How to Present Your Price

Show That Your Price Is Reasonable

When 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 Risk

Generally, 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:

• The right information provided at the right time can alleviate an investor's uncertainty and lower the perceived risk.
  
• The flow of information to the investor should continue through the negotiation process.

When to Present Price

The best time to disclose your price may vary depending on the type of investor you are approaching.

• Inexperienced Angels. If you're dealing with inexperienced investors (e.g. local angel investors who don't know how to price the investment appropriately), you may have decided to include your asking price in the investment proposal. Disclosing your asking price will help these investors calculate the expected return on the proposed investment. But remember that revealing your price effectively means setting a price ceiling.
• Experienced Investors. On the other hand, if you're dealing with experienced investors, it might be advisable not to indicate your price. These investors, who should have the expertise to value your business, could arrive at a higher value than you anticipated. If you have approached several interested investors, resist disclosing your asking price until you see what they offer.

Assessing Offers

Convert All Offers Into Their Cash Equivalency

In 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:

• various forms of equity, near equity and non-equity instruments;
  
• mechanisms to adjust equity participation from time to time;
  
• buyback rights based on predetermined prices or formulas; and
  
• staged payment terms.

Don't Forget Non-Tangible Aspects

When 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 Gap

Reaching 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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