In the last couple of weeks I’ve met several times with a client who’s about to do an Angel funding round. Like most entrepreneurs, he values his company based on its potential rather than on what it’s actually delivered.
He points to the enthusiasm with which his product is being greeted by key players in his target market, and to his worldwide patents. I point to the fact that he has not yet got his first paying customer. He enthuses about the scalability of the business, while I highlight the risk factors which stand between him and success.
We have agreed that the fund-raising will be via a convertible note, thus deferring the valuation issue until the next round. He’s happy because he is sure he’ll have market validation by then, and I’m happy because if he gets that validation the investors’ view of the value will be much closer to the founder’s.
This situation, repeated in most of my very early fund-raising projects, highlights the biggest point of difference between investors and founders; investors aren’t comfortable until they see real customers, while founders treat strong leads and champions within target customer companies as sufficient proof of concept.
The old saying “The proof of the pudding is in the eating.” springs to mind. Until founders find someone to ‘buy and eat their pudding’ the value of the product cannot be said to be proven.
Because of the irreconcilable difference in opinion between the founders and the Angels, I’m doing more convertible note deals. Although that process de-risks the investment for the Angels, not all of them are happy. Some would rather hammer all founders to low valuations when they don’t have market validation, and pick up a substantial value uplift when the validation is delivered. Others won’t invest at all until the company has paying customers. After all, market validation is just another business-building risk factor… different Angels have different appetites for absorbing that risk in their investments.