They say venture capitalist would like a 40% IRR which is an approximation of their ROI, but this is all fantasy based on assumptions that drive the financial projections. Pessimistic projections can be used to negotiate lower pre-money valuation prices. So the CEO/Founders are selling the potential while the investors are selling the downside risks.
Angel investors would like to see good returns like this too, but are unlikely to develop their own models to their own assumptions as the amount of work involve is large, and they have no associates to do that work. Angel syndicates on $1M+ deals might do this work though and use their results to negotiate equity prices.
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The reality is few deals ever perform anywhere near their projections as there are too many unknowns that early on to have any confidence. The numbers will be rerun every time there is a learning experience and could go up or down dramatically. Angels are protected for a while by the convertible note mechanism because no valuation was set yet for them.
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VCs may ask for retroactive reduction in past prices to protect them from “Down rounds” but the reality is everyone cannot get this protection as the new equity must be created to bring in the next investment. There are many scenarios that would require a book or two to cover, but the bottom line is when things are going well, they are usually easy to resolve as investors are seeing their equity price climb. When things are not going well, the increasing tension can cause tough negotiations. However, what is true is everyone suffers if a deal is not made to continue. Without an agreement to move forward with the majority of investors, everyone’s investment becomes worthless. This is the proverbial “gun to the head” any CEO has to drive the next investment deal. And usually, investors just want to see their stock continue to have more time and money to blossom.
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Bob Norton is a long-time Serial Entrepreneur and CEO with four exits that returned over $1 billion to investors. He has trained, coached and advised over 1,000 CEOs since 2002. And is Founder of The CEO Boot Camp™ and Entrepreneurship University™. Mr. Norton works with companies to triple their chances of success in launching new companies and products. And helps established companies scale faster using the six AirTight Management™ systems. And helps companies successfully raise capital.