Beauty lies in the eyes of the beholder. Metaphorically, one could say this applies to valuation and other key matters of term sheet negotiations as well.
- By Jitesh Agarwal
As startups try to understand and cope up with the impact Covid-19 will have in the near term and in the longer term on their businesses, the disruption on account of the global pandemic has left many in an extremely difficult position – either many have lost their identity as a relevant business or many lack cash runways to operate without the fear of losing out to their cash-rich competitors.
Both these situations have prompted startups to scramble for funds while re-organizing teams and working on pivotal projects to stay relevant and afloat. In the process, many have been forced to knock doors they would have otherwise never knocked, going back to terms sheets they would have previously passed because it may not have met their expectations, either financially or strategically.
The thing about negotiating a term sheet in difficult times is that it mostly always starts with the question, who came to whom? And the answer mostly always is that the founders have less leverage in the negotiation from the start. Agreeing on valuation and other key terms can be really tricky when one side is in a difficult situation and the other side is aware.
Beauty lies in the eyes of the beholder. Metaphorically, one could say this applies to valuation and other key matters of term sheet negotiations as well. The question now though is – that for how long, can the beauty bedazzles the eyes of the beholder and which beholder it wants to bedazzle? And the answer to this lies in how much of the value is being created in business after the pandemic is over provided that the business is still relevant once this nightmare is over and what type of investor the startup will partner with.
For all those businesses that are now down but will fully recover to its pre-Covid state by 2023 and may most likely grow at a good pace after, if still relevant, like startups in the travel, health, fitness, food, and beverage, delivery space, etc., the concern for the founders will be to have enough cash to maintain teams, innovate and keep engaged with customers. In this case, the founders can re-assess the incremental burn it would take to acquire paying customers in 2023 and beyond that were lost in 2021 and 2022 to haggle with investors for dilution at previously valued rounds. This may not have been very far apart considering we are only into the sixth or seventh month of the pandemic.
For all those businesses that are now shining thanks to Covid, like e-commerce, video calling, OTTs, Online skilling, etc., this can be a good time for founders to earn out better than promised numbers and re-negotiate valuations/dilutions. Although, while negotiating, one must keep in mind the value adjustment in the future due to drops in growth rates or an increase in the share of customer wallets. For all those businesses that are now currently irrelevant generally or due to Covid, like say, Intel Inc., well good luck finding the money.
In conclusion, business valuation will depend on the assessment of the relevance of a business in a post-Covid world. Valuation for relevant business models may not really get impacted by a pandemic which although destructive, is presumed to be short-lived.
This hypothesis might just hold good because, well, look at the S&P IT Index, a benchmark technology index, which is now sitting at a 10 year high in the seventh month of the pandemic while businesses that fail to stay relevant are losing their shine.
Jitesh Agarwal is the Founder of Treelife Consultancy. Views expressed are the author’s own.