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Here’s how healthcare startups can avoid blowing trick questions from investors

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Note: This is the second part of a series on helping startups steer clear of tricky investor questions.

Investors turn down more than 95 percent of the deals they see. They are looking for reasons to quickly reject them. Simple questions, when answered incorrectly, will quickly land startups in the no bucket.  As described in my previous article, “What’s your exit strategy?” is one of those trick questions that most founders get wrong.  Let’s look at some more questions that fall into the same category.

How much are you raising?

First, investors should not even have to ask this question.  This should be stated right at the beginning of a pitch and called out in the one-pager — often called “the ask”.  The more common mistake is answering with a range. Most entrepreneurs say something like, “We are raising $3 million to $5 million.”  You are either raising $3 million or $5 million, but not anything in between — this is not a multiple choice question. Answering with a range will make investors wonder whether you have a plan that you believe in that’s also backed by a detailed financial projection.  

When investors look at your projections, they expect to see cash requirements that align with a clearly defined set of time-based milestones.  These milestones must either put the company in a position to raise more capital at a higher valuation or be acquired. Figure out the exact resources and budget needed to achieve these milestones, add some cushion since it always costs more and takes longer, and confidently state this as the amount you are raising.  

Providing a range also projects a lack of confidence. You might as well say, “We are raising $5 million, but if we are unable to raise that much, and you are willing to give us $3 million, we will take it.”  If you have built out a detailed projection tied to milestones, you will be prepared to answer this question without hesitation. Carefully build a plan your team believes in, then present it with passion and confidence.  

What is your valuation?

A basic rule of negotiation is to never offer the first number.  Additionally, entrepreneurs often fall in the same trap we discussed above. They give a range. “Based on our last valuation, traction, and milestones, we expect a pre-money in the $12 million-$15 million range.”  Seems reasonable, right? However, this a huge mistake. Here’s why.

First, the investor only heard the lowest number, so we are starting at $12 million If you were buying a car, and the seller said she wanted $15,000-$17,000, would you even consider $17,000? Of course not. If we move forward, you may be leaving equity on the table. On the other hand, the more likely scenario is that your valuation sounds too high. The investor believes you have unreasonable valuation expectations and the discussion is over — expressway to the “Life’s too short” bucket.  

Here’s the critical takeaway.  The market sets valuation not you, your team, your investors, or your board and that is determined by supply and demand. Investors don’t really care about the last round’s valuation or all the milestones that you feel justify a big step up. Valuation is determined by many factors, not the least of which are market conditions and competition. Want a higher valuation? Get competing term sheets. Do you have only one term sheet?  Expect tougher terms. If you believe in supply and demand, there is no such thing as an unfair deal. I frequently remind entrepreneurs that if they think a deal is grossly unfair, they should find a better one — you do not have to take the money.  

Ultimately, the math is simple.  The investor believes your company has a reasonable chance of achieving a certain exit valuation.  We then back out the maximum post-money valuation to deliver a venture level return. For example, an investor may think you have a good chance of being acquired for $100 million in a few years.  VC’s are typically looking for a 5x-10x return. So in this case, the maximum post-money valuation is $20 million for a 5x return, assuming the company will not be raising any more capital. If the raise is $5 million, the maximum pre-money is $15 million which results in a $20 million post-money valuation.  If the company sells for $100 million, we would get a 5x return. This is a bit oversimplified, as other factors including participation preferences and the dividend rate come into play, but you get the idea.

So here’s a better a way to answer the valuation question:

“The market will determine our valuation.  We have a lot of investor enthusiasm and discussions seem to be going well.  We think your firm would add tremendous value as an investor and we would be delighted to provide any information that might help move us forward.  What are the next steps in your process?”

Fundraising can be a long slog.  Answering questions in a thoughtful and sophisticated way can help earn respect and improve the probability of success.

Photo: Getty Images

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