Pre-money Valuation, Due Diligence und Risk Assessment based on Strategic Failure Management

Anyone who has worked towards achieving buy-in from preferred investors knows that the process is not simple. Between the negotiations and bargaining, both founders and investors are tasked with the difficult challenge of balancing the deal. But for investors, this process is a part of their daily routines – the same cannot be said for founders. So how can entrepreneurs appeal to preferred investors and get the buy-in they’re looking for?

The secret will help you and your team become more proactive and less reactive by addressing failure at its core. We call it the Beat Failure methodology. All you have to do is explore one simple question: what would cause you to fail?

Let’s look at four stages of the investor/founder relationship in which addressing potential failures can help you as an entrepreneur lead conversations, generate trust and alignment and ultimately gain the confidence and certainty you need to attract investors.

I Pre-money Valuation

Pre-money valuation prior to investment conversations is one important element in the investment process that can help startups experience rapid growth. The formula is easy: the higher your pre-money valuation, the easier your conversations with a new round of investors will be. Higher estimates will not only attract larger sums of investment money, but it will also attract more experienced investors to your startup. But how can you leverage communication to influence the pre-money valuation process?

This is where failure comes in. One way to discuss how much equity should be issued in return for an investment in your company is by exploring what potential failures investors anticipate and what you can do to preemptively prevent such pitfalls from occurring. The art of predicting potential failure points and managing your company from a failure prevention standpoint (rather than solidly based on KPIs and vision) sends a strong message and effect to your pre-money valuation. As a result, your critical pre-money valuation is not entirely in the hands of potential investors but rather shaped by your proactive failure planning approach.

II Investor Pitch Deck

Don’t let all of this failure planning happen just behind the scenes – include a potential failure slide in your investor pitch deck. Business plans, product USPs, market entry and expansion strategies and competitor briefings are essential to any good pitch – but one extra minute of failure planning will add tremendous value to your deck.

After addressing the risk assessment needs of your potential investor, add one last slide displaying any potential points of failure and contrast them with the precise measures you plan to implement to counteract such pitfalls. This extra step has been found to help increase trust between investors and founders to a great extent. One extra slide on your pitch deck gaining disproportionately more trust is a no-brainer if you ask us.

III Due Diligence from the Founder’s Perspective

Risk assessment and due diligence are key parts of any investment round. In order to assess which investor suits your portfolio, you want to make sure to define the experience and network you’ll need to maximize growth. This is where failure comes in again – focusing on failure can help you understand which investors are the best fit for you and your company. Set up a table with a column collecting your possible failure items and add a column for each investor you’re having conversations with and start vetting them via this matrix of failures. It is important to remember that you are evaluating these investments as well. Without having a clear vision of your criteria, it is easy to get flattered into a detrimental partnership.

Ask yourself: which investor will help you combat such failures? And choose accordingly.

IV Risk Assessment + Relationship Building Together with your Investors

You’ve come a long way after initiating your next investment round. Now is the time when a handful of investors remain and the round is about to close. In order to finally achieve buy-in from your preferred investor(s), let strategic failure management be your last push towards success.

Get your potential cap table or 2-3 competing investors for your next round to the table and invite them proactively (again) to a holistic and joint due diligence by sharing openly what you think would cause your company to fail. This final exercise and fourth use case of the Beat Failure methodology allows you as a founder to compare everyone’s concerns and assess them by directly comparing the suitability of your investors at the table.

Secondly, conversations like this allow you to mitigate risks. Ideally, you already conducted a ‘what would cause us to fail’ due diligence internally and identified measures to be taken in order to prevent failure from happening. In this final get-together you can showcase your strength of having anticipated failure and impress investors one last time. As a cherry on top, you can also add emotional intelligence (EQ) based due diligence to the fact-based due diligence in order to build a strong relationship with your future stakeholder(s).

Beating Failure with strategy

Conclusion: Beat Failure methodology offers both sides in the due diligence process the opportunity to anticipate failure, identify concrete strategies for failure items and communicate mutual expectations. As a confidence-building measure, the approach established in Silicon Valley has brought many startups and investors together in the right combination, producing clear action items to prevent failure from happening. Don’t fail fast, fail often, but make failure a tool by making ‘Strategic Failure Management’ part of your conversations – in the due diligence and risk assessment process with your investors and startups. Because you can actually Beat Failure.