Have you watched an episode of “Antiques Roadshow”? If so, you already know the best way to properly price a funding round.
I can see you are confused. Let me explain.
Picture this: A possible seller has brought in a vintage watch for valuation. He takes it to a respected expert who offers a well-informed (and neutral) perspective on what price it should command at auction.
When making a valuation, the expert will take a variety of aspects into account.
Looking ahead, they are going to consider the rarity of the watch and due to this fact how much higher the price will likely be as supply decreases over time. Scarcity causes value to extend. You can think of this as an estimate of the increase in value or future returns.
Looking at the present, they are going to consider the specific history and condition of the watch, and with these aspects in mind, the way it compares to similar watches that have recently sold at auction. You can think of this as an estimate of value by comparison.
Finally, when looking at the market, they are going to consider trends. Does the watch represent a specific style or category that is popular at the moment? Have there been recent events which may spark interest or attention for the sort of watch?
From these three perspectives, the expert tries to triangulate the valuation with the biggest certainty possible. The goal is to tell the seller about the expectations and help set the appropriate opening bid to make sure a successful auction.
Let the bidding begin
The ultimate test is the auction itself. Here, a room stuffed with buyers will view the watch, including the value suggested by the appraisal, and determine whether or not they wish to bid. There are several key aspects that may affect the final consequence.
Who are the typical buyers of a majority of these watches? Are they institutional investors trying to build a portfolio of different assets that could be more affected by different market cycles? Or are they private collectors who are more discerning and price-sensitive but also more consistent in their interests?
Is your opening bid in line with the buyer’s expectations? Have you made a good case for the assessed value based on the details provided in the auction brochure? Well-informed private buyers may give you the chance to intuitively predict a significant slice of the value, while larger institutional investors may have more education.
Finally, for the specific watch you are offering, do you have the right buyers in the room? If it is a part of a watch collection, are those collectors present? If it is a popular style, has it been widely broadcasted enough to draw interest? Ideally, there must be a number of interested parties to be certain that the bidding will drive up the price.
So the hammer falls. The bidding is over. The watch has been sold. It had an appraisal, and now it has a price.
Financing your startup
As you’ve got probably already gathered, this is an allegory for startup funding that comprises one vital lesson.
Many investors will inform you that deals are all that matters; that it is best to let the market dictate the terms. This is an oversimplification that assumes great sophistication on the a part of investors and great efficiency in the market. While this is an attractive idea for investors, it is simply not realistic.
This assumption doesn’t take into account the work founders have to place into running a solid fundraising process to make sure investors are on board: developing a coherent offering, promoting the opportunity, and educating their audience.
Valuation is rational and objective, but theoretical. Price is subjective and opaque, but absolute. Make sure you do it right.