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"Matt Takes A Whack At Stubborn Valuation Question"
July 12, 2000

Matt Bolton says he's always asked this question when he sits on a Venture Capital panel: "How is valuation determined?"

So Matt, what's the answer? When I asked him this question a couple weeks ago he said, "Mike, the market will dictate the value. It has a way of working itself out."

I thought about that for a couple weeks and decided I had no idea what that meant.

So Matt, can you help me out? "The only way you can really determine a valuation is to go through the process. And both parties must remain flexible. I can tell you what some of the factors are - the strength of the management team, market size and leadership, the competition's obstacles to entry, potential return on investment.

"But it still can be a subjective process. It's not like putting a value on a public company," Matt says.

Comparables can come into play, such as valuation determined in similar deals. There can be back-and-forth negotiations.

"There hasn't been a huge discrepancy over valuation with the deals we've done," Matt says. "A lot of it has to do with the partnership that has been built during the due diligence process and how much both sides are willing to work with each other.''

But both sides are trying to make the best deal possible for themselves, right Matt? Doesn't a company have to watch out for someone taking advantage of them?

"There can be that risk, but then it is a question of how do entrepreneurs choose their investors. Entrepreneurs need to do their own due diligence on potential investors just like we're evaluating their companies. One of the jobs of a CEO is to do what is best for their shareholders.

"But to do it right you have to have realistic expectations about valuation, be open and listen to what potential investors are saying. Many people don't do that."

Qualified early-stage companies (first institutional round of financing) with previously successful management teams could have values that range between $2 million and $20 million with most being toward the higher end of the range, Matt says. Investors tend to pay a premium for “been there, done that" executives.

Matthew J. Bolton is an analyst with Woodside Fund, a leading early stage venture capital fund who partners with visionary, passionate and talented entrepreneurs in building innovative technology enterprises. Founded in 1983, the firm has four funds with more than $200 million under management.

Here is a glossary of terms you'll need to know before you make your pitch to investors:


Woodside Fund will work with you to determine an appropriate valuation for your company. It’s not something you have to figure out on your own. Simply put, the value of a company is what drives the price investors will pay for a piece of the action. The information used to determine valuation comes out of the due diligence process, and has to do with the strength of the management team, market potential, the sustainable advantage of the product/service, and potential financial returns. Another way to look at valuation is how much money it will take to make the company a success. In the end, the value of a company is the price at which a willing buyer and seller can complete a transaction.

Fully Diluted

Ownership and valuation is typically calculated on a fully diluted basis. This means that all securities, including preferred stock, options and warrants, that can result in additional common shares, are counted in determining the total amount of shares outstanding for the purposes of determining ownership or valuation.

Type of Security

Investors typically receive convertible preferred stock in exchange for making the investment in a new venture. This type of stock has priority over common stock if the company is acquired or liquidated and assets are distributed. The higher priority of the preferred stock justifies a higher price, compared to the price paid by founders for common stock. "Convertible" means that the shares may be exchanged for a fixed number of common shares.

Liquidation Preference

When the company is sold or liquidated, the preferred stockholders will receive a certain fixed amount before any assets are distributed to the common stockholders. A "participating preferred" stockholder will not only receive the fixed amount, but will also share in any additional amounts distributed to common stock.

Dividend Preference

Dividends are paid first to preferred stock, and then common stock. This dividend may be cumulative – so that it accrues from year to year until paid in full, or non-cumulative and discretionary.


Preferred stock may be redeemed or retired, either at the option of the company or the investors, or on a mandatory basis, frequently at some premium over the initial purchase price of the stock. One reason venture firms want this right is due to the finite life of each investment partnership managed by the firm.

Conversion Rights

Preferred stock may be converted into common stock at a certain conversion price, generally whenever the stockholder chooses. Conversion may also happen automatically in response to certain events, such as when the company goes public.

Anti-dilution Protection

The conversion price of the preferred stock is subject to adjustment for certain diluting events, such as stock splits or stock dividends. The conversion price is typically subject to "price protection," which is an adjustment based on future sales of stock at prices below the conversion price. Price protection can take many forms. One form is called "ratchet" protection, which lowers the conversion price to the price at which any new stock is sold no matter the number of shares. Another form is broad-based "weighted average" protection, which adjusts the conversion price according to a formula that incorporates the number of new shares being issued, and their price. In many cases, a certain number of shares are exempted from this protection to cover anticipated assurances to key employees, consultants and directors.

Voting Rights

Preferred stock has a number of votes equal to the number of shares of common stock into which it is convertible. Preferred stock usually has special voting rights, such as the right to elect one or more of the company’s directors, or to approve certain types of corporate actions, such as amending the articles of incorporation or creating a new series of preferred stock.

Right of First Refusal

Holders of preferred stock typically have the right to purchase additional shares when issued by the company, up to their current aggregate ownership percentage.

Co-Sale Right

Founders will often enter into a co-sale agreement with investors. A co-sale right gives investors some protection against founders selling their interest to a third party by giving investors the right to sell part of their stock as part of such a sale.

Registration Rights

Registration rights are generally given to preferred investors as part of their investment. These rights provide investors liquidity by allowing them to require the company to register their shares for sale to the public - either as part of an offering already planned by the company (called piggyback rights), or in a separate offering initiated at the investors’ request (called demand rights).

Vesting on Founders’ Stock

A percentage of founders’ stock, which decreases over time, can be purchased by the company at cost if a founder leaves the company. This is a protection for the investors against founders leaving the company after it gets funded.

To learn more about term sheets and valuation, you may want to take a look at these books:

The Silicon Valley Way by Elton B. Sherwin

The Small Business Valuation Book by Lawrence W. Tuller

Guide to Business Valuations by Jay Fishman



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