Answer by Leo Polovets, General Partner at Susa Ventures, codingvc.com, on Quora

I haven't heard of founders literally negotiating lower valuations, but I've seen people take lower valuations either because they prefer the firm that's offering a lower valuation, or because the higher valuation sets up unreachable expectations.

Here's a hypothetical:

- Let's say that past a certain point, companies are generally valued at 12x ARR. For example, $10m ARR -> $120m valuation.

- You're at $4m ARR and think that with a $10m investment you could get to $10m ARR in 15 months.

- Someone offers you $10m at a $50m pre.

- Someone else offers you $30m at a $150m pre. You believe that a $30m cash infusion would help you grow to $13m ARR instead of $9m (if you ramp up your spending a lot), but there are factors besides money that limit your growth rate.

In this hypothetical, if you raise $10m at a $50m pre right now, you can get to $10m ARR and raise at a $120m pre next year. Great. However, if you raise $30m at a $150m pre, you can get to $13m ARR and a $156m pre. That's not ideal because your pre-money on your next round is lower than your post-money on this round. As a result, you might get bad terms for the next round, or not be able to raise at all.

One solution is to take the $30m and to only spend $10m in the next 15 months as originally planned, but investors will be encouraging you to spend more and grow faster.

As I mentioned, I haven't seen someone literally negotiate a lower valuation on a term sheet, but I have seen the expectations that come with a valuation be a factor when deciding between term sheets.

It's very hard to have the discipline not to take a really sweet looking offer. Just like a kid won't say no to an extra helping of dessert (even though they know they might get a stomachache), most founders won't say no to great terms, even if they end up regretting that later on.

Two other ideas:

1) If an investor offers $20m at a $100m valuation and crappy terms (e.g. egregious liquidation preferences), it might be better to negotiate the valuation down in exchange for better terms.

2) A lower valuation makes acquisitions easier, and in the case of an acquisition, lowers the hurdle price at which the founders make meaningful money. For example, if there's a 2x participating preferred liquidation preference, then raising $10m at a $40m pre and selling for $65m means the founders split $36m. If the company raises $20m at an $80m pre, struggles, and sells for $65m, then the founders split $20m.

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Published on: Apr 16, 2015