“Tell me the journey of my money.”

Not all great technologies make great companies. And not all great companies make great investments. All too often I see entrepreneurs pitch a great technology and a great company to venture investors, but they fail to make the case for a great investment. The key to pitching a great investment is to tell the story of your company’s future growth and eventual exit. The story needs to be aggressive enough to satisfy the investor’s return requirements, but credible enough that they believe you.

Aggressive, but credible.

In episode #39 of the podcast The Pitch, Stefan Loble, founder of Bluffworks, a men’s apparel startup, pitches to four venture investors. About 16 minutes into the episode, a brief but critical exchange occurs between Loble and one of the investors. It takes less than a minute, but it is the exact point in which the founder transitions from pitching a great company to a great investment.

Here’s how you can do it, too. Click on the video below to hear the audio clip of this exchange. I’ve typed out the rough transcript of this brief exchange, paraphrasing and editing for the sake of clarity and brevity. Don’t worry if some parts are confusing — the analysis below will hopefully clear things up.

Now let’s break it down and fill in some of the nuances.

Up until this point, the pitch has been very focused on the founder’s backstory and his unique products. Then, angel Michael Hyatt steers the conversation away from product to gauge how the founder plans to manage the company and the new infusion of capital he’s raising. The founder articulates that he has a plan to use the capital to grow the company over the next two years. Although we are not privy to the details of this plan — and details are indeed important — the founder does earn a couple points for credibility: the first point for simply having a plan; the second point for having a plan that is bounded by an appropriate amount of time.

Let me expand on that second point. Investors do not invest in runway; they invest in value creation. And founders (especially seed/A stage) should not raise as much money as they can; they should raise as much as they will need to hit a few critical milestones that definitively increase the value of their company, and then raise another round at a higher price once those milestones have been achieved. Two years is a reasonable time frame to execute a growth plan. 6–12 months is too tight (in most cases) and will expose investors to too much risk. Much more than 24 months and investors will get impatient with your plan. Of course every situation is unique, but 18–24 months is typically the sweet spot.

Then the investor starts to dig in a little more. Tell me the journey of my money. It’s starting to feel a little more personal. And why shouldn’t it? He’s an angel investor — it’s his money! So what exactly does he mean? He’s saying… This is an extraordinarily risky investment. And, therefore, I expect extraordinary returns. Your ability to make nice clothes that people want to buy does not guarantee my extraordinary returns. So tell me from a financial perspective how my investment will yield extraordinary returns. Prove to me that the market will reward you for the value you create over the next two years and beyond. That’s what he means.

Does the founder read between the lines and offer a strong response?

Yes. He’s prepared to tell him the journey of his money. Is the journey sufficiently aggressive and credible?

Let’s walk through this last part step-by-step.

1. He sets today’s valuation at $6 million. Whether or not this price is acceptable to the investor, it serves as a reasonable starting point for the financial journey ahead. [Side note: his valuation is a bit ambiguous. Valuations must be identified as “pre-money” or “post-money”, and pre-money is more common. Stating the $600k investment would garner a

10% stake in the company implies he is using a post-money valuation in his calculation.]

2. His two-year growth plan gets the company to $13 million in annual revenue (he states earlier in the episode that they did $2.2 million in sales last year). Is the two-year plan aggressive? Yes. Is it credible? Sure, if you buy into his product and marketing strategy, but that’s another topic for another time.

3. Then, two years later, comes the Series A raise at a $20 million valuation. How does he substantiate that price? He’s deriving it from the projected $13 million of sales. So, assuming he hits his sales target, is that valuation in line with the market? I don’t know, this (apparel) isn’t my area of expertise. But there are a few different ways we can value a company. The most common way is the discounted cash flow methodology (DCF), in which future cash flows are discounted and summed up to determine the net present value (NPV). This method is great for corporate finance, but not really a good method for pricing early-stage startups because the investor and founder would likely never agree on what those cash flows will be.

A more common approach is to look at market comps, i.e. the valuations of other Series A deals for similar companies (apparel). Here are a few comps:

Apparel Comps for Series A Financings

So the Bluffworks founder’s suggested future valuation is in the ballpark of what VCs are paying today.

However, not all Series A rounds are created equal. The term ‘Series A’ comes with no formal requirements and typically only refers to the next priced round of investment after a ‘Series Seed’ round. Ultimately the valuation still needs to be substantiated by the company’s current stage of development and/or market traction. We don’t know revenues for each those apparel comps at the time of their A round investments, but if Bluffworks gets to $13 million in sales in two years, I’d argue a significant amount of risk has been squeezed out and a $20 million post-money valuation is reasonable.

4. He plans to raise $2 million for a 10% stake in the company. Similar to the issue I raised in part 1 above, he is implying a post-money valuation without actually specifying it. Ok, though, still a credible journey. But the journey is not yet complete. Early-stage investors must consider the impact of future dilution on their investment. In this journey, the founder assumes the seed investor does not participate in the A round, and his stake in the company is therefore diluted from 10% down to 9%. The math is simple enough — 10% of 10% equates to a 1 percentage point decline. Note that this also assumes any newly created options pool is included in the $2 million of new shares. And let’s not get hung up on employee stock options here; check out this article from a16z for a good explanation.

5. Finally, the founder gets to the journey’s exit — the pot of gold at the end of the rainbow. Notice he sets his targeted acquisition price based on the return requirements of the investor he is actively pitching. Great move! By directly stating, “I need to get you a 9X return”, he is saying I have your financial interests in mind. I will do whatever it takes to meet and exceed your return expectations. He then backs out the price he needs to get to meet those requirements: $90 million. This price is based on the founder’s expectation that he can grow the business to $50 million in revenue. Is the $50 million forecast credible? It’s pretty aggressive, and a timeframe is not specified, but it is doable.

Assuming the company gets to a $50 million revenue run rate, we can gut-check the founder’s targeted acquisition price using a third methodology: multiples. What do public markets pay for similar companies? To find the answer, we can turn to NYU Stern School of Business Professor Aswath Damodaran, a leading authority in corporate finance and valuations. This table tells us the ‘Price:Sales’ multiple for apparel companies is 1.56, i.e. investors will pay, on average, $1.56 for every $1 in annual revenue. And the same ratio for online retail (all e-commerce) is 3.32. So, a scaled-up Bluffworks multiple would be somewhere in between those two data points. Thus, the $90 million price tag is credible (90/50=1.8).

Actually, an exit in the neighborhood of $70 million would get the investor a 9X return. The founder may have goofed up the math, which goes to show you can never be too prepared to tell the journey! Having said that, aiming for a higher acquisition price is a good idea because the full amount paid by the buyer will not exclusively go to shareholders. There will likely be a line of credit or some other debt facility that needs to be paid off, plus legal fees, banker fees if the transaction was brokered, and most likely some expenses associated with managing the post-transaction seller’s rep.

Overall, the founder does a really good job of concisely and directly pitching a good investment. There are always more details to uncover, but with limited time to grab an investor’s attention, founders need to be very clear in how they plan to multiply seed capital by orders of magnitude.

Thanks to The Pitch for putting great content out there. Did the investors end up participating in Bluffworks’ seed round? Tune in and find out for yourself.

Special thanks to Ben Gaddy for providing his input on this article.