A valuation gap refers to a situation where the views of the investor and the entrepreneur on the value of a company differ from each other. This is usually due to a situation where the investor optimises returns and wishes to minimise the valuation, whereas the entrepreneur wishes to maximise the valuation and through this his or her holding. The difference in view on the valuation of the company is one of the most common factors responsible for investment negotiations being discontinued. A valuation done incorrectly may also prevent follow-on rounds and hence drive the company into a financial impasse.
A company seeking angel investment must form a reasonable, justifiable view of the company’s valuation. It is simply ludicrous that a similar company may be availablefor EUR 100,000, but the valuation presented to the investor is EUR 1 million.
In situations where the investment target is especially interesting, an incorrect valuation not only interrupts negotiations immediately but hinders and complicates them. Understandably, poor investor terms reduce the valuation and good ones increase it. Factors with a positive impact on the decision-making (and valuation) of investors include (see explanations, chapter 4)
- salaries and remuneration of founder shareholders, vesting terms
- allocation of board of director seats
- provisions limiting share dilution
- veto rights in issues
- rights to receive information
- later registration and pre-emptive subscription rights (warrants) as well as drag-along obligations (and tag-along rights)
redemption obligation of shareholders (e.g. an investment as a loan, which an entrepreneur is obliged to pay 0.5X back to the investor if the plan is not realised)
- various series of shares and conversion and other terms between share series (e.g. dividend, voting rights)
- reputation, name and experience of investor as well as added value for the company
- other special conditions, such as a liquidation preference, a full ratchet provision
Ultimately the valuation of a company is the price accepted by both parties, which in addition to the above, is influenced, by among other things, the general market situation and negotiation position at the time (which party must obtain an agreement and which can refrain from it).