Whether they like it or not, Founders tend to spend a lot of time trying to raise money. After establishing that they want or need the money, the next question they always confront is how much they are worth. Or more specifically, what value can they set on their company and their equity in it – to sell that equity to an investor. This is known as their “valuation.”

Often the valuation is established by trying to compare the company to various financial or performance metrics. But to some extent, I think that misses the point. I would argue, instead, that it’s more important to think about the factors that make an “investment opportunity” attractive to investors. Why would an investor want to own part of the founder’s company.

I think there are three important motivations to consider. For ease of remembering, let’s reduce them to acronyms and call them “The Big O’s” – a cultural reference that only Canadians of a certain age will recognize – but I digress.

The Big O’s are:

1. FoMo – Fear of Missing out
2. MoMo – Make Others Miss Out
3. GoBoGoH* – Go Big or Go Home

I really do believe that Investors who are excited about an investment opportunity are usually responding to at least one – and probably more than one of these motivations.

Let me explain. But let me start with the last motivation since it is almost always present – although, it must be said, that sometimes the enthusiasm that is shown for this factor is matter of some serious confirmation bias.  In other words, if an investor has FoMo and MoMo then they will usually convince themselves to have GoBoGoH too.  But – perhaps I am getting ahead of myself.

Stripped of the narrative need to come up with a cute acronym, what I mean by Go Big Or Go Home is that any investors needs to be convinced that the investment they are being asked to make has a good chance of generating a large return. Now, different investors will have a different working definition of “large” in this context. But, in general, the size of the return required to generate investor enthusiasm will be based on two factors. These are: how risky the investment seems to be and how long they expect to have to wait to be able to realize the return. In general, the larger the risk and the longer the wait – the larger the return an investor will expect from a given investment.  This is often referred to as the IRR or Internal Rate of Return of the investment.

Now to get technical for a moment, Internal Rate of Return is an investment term which refers to a “time value of money” calculation that is formally defined as “The effective interest rate earned if the Net Present value of an investment is set to zero.” 

All of which is just another way of saying it’s a way that an investor can calculate the effective compound interest rate earned from their investment once they sell it. This allows investors to compare the performance of their invested funds to other metrics like a bond or a stock market index. Obviously, investors would like to see their investments outperforming these metrics. Substantially.

The factors that go into calculating an Internal Rate of Return are straightforward. They are the amount invested, the amount returned to the investor and the amount of time elapsed between the two events.  The calculation can be complicated by having more than one “payout” event but for our purposes here we are normally talking about a single-entry point when equity in a company is purchased and a single exit point when the equity is sold to another investor or investors at a later date.

So, to calculate their expected Internal Rate of Return an investor will decide how much equity they would like to own, they will then think about when they believe the company might be sold and for how much. That will be their return. Finally, they will look at what amount of money they are prepared to invest in order to make that internal rate of return match their perception of the risk between the them and the promised land of the expected exit.

In other words, they will decide how much they are willing to spend to acquire the desired portion of the target company. Which will, in turn, set the overall valuation of the company that they are prepared to consider. 

Now for most founders, on the other hand, this calculation is done in reverse. A Founder typically starts by figuring out how much they think they are worth and then calculating how much of that value they are prepared to offer for sale in order to obtain the funds they need.

But it is important for founders to realize that ultimately, the investor calculation works in the opposite direction. Typically, an investor will need to work backwards from the exit to determine how much they are willing to invest in order to make the rate of return commensurate with the risk of the investment.

As I said at the beginning – this “valuation” is at the heart of any fund-raising deal. It is the primary statistic around which the “term sheet” revolves. And let’s face it, no small amount of the founder’s perception of their own self-worth is tied up in this number. Not surprisingly, founders will want to seek tangible reasons for the value that they want to set. They will turn to things like multiples of revenue or profit, or the value of IP that has been protected, or the size of their sales funnel. The value of their Total Addressable Market. 

But at the end of the day, these are all just ways of trying to come to grips with the variables in the IRR equation. How long will it take to reach an exit?  How much will someone else be convinced to pay at that point? How likely is that outcome? 

So, valuation is much less about what you think you are worth – it is really about what you think you WILL be worth in the future. Founders need to tell that story. And basically, every investor will want this story to convince them that this opportunity is going to Go Big. Otherwise, they will Go Home and find another one.

So, this now, is where the other two factors; FoMo and MoMo come into the equation. And that’s because the numbers in the IRR equation are all, effectively, notional. Yes, they can all be connected to tangible factors but at the end of the day they are all estimates. They are also estimates that are strongly affected by what I will call “Market Sentiment” or more concisely just “Sentiment”.

By this I mean that investors view of the risk, size, and timing of an exit are strongly affected by their perception of how the company and the opportunity it represents are viewed by others. 

This makes sense, because, of course, a successful exit will mean finding someone who will view the company as being much more valuable than it was when the investor made their investment. If the company is working in a sector or on a technology which is currently attracting a lot of positive attention on in the mainstream or social media – or in the investor community – then it will be seen as being more likely to appreciate in value. In other words sentiment matters in determining valuation.

Thus, investors justifiably believe that their success depends on their ability to benefit from monitoring band track this kind of sentiment. But, benefiting from this ability to track market sentiment requires investors to spot trends early as they arrive and also to spot when they are peaking so that they can exit before the peak. 

So, if an investor senses a trend developing, they will want to get in before the rush develops – in other words they will be afraid to “miss out” on the trend. In other words, they have Fear Of Missing Out.  Likewise, if they believe they have spotted an early trend they will want to move to get ahead of “the pack” and ensure they get the best “seats on the bus” – and leave other investors standing at the curb.  Which is what I am calling a desire to “Make Others Miss Out”.

Understanding these motivations and finding ways to generate them in potential investors is something that founders who are good at fundraising learn how to do. It doesn’t come naturally to everyone, and it’s not always possible to pull off.  But it can be effective.

Maybe that’s worth another column.  Send me some feedback on LinkedIn and let me know what you think.

* Editor’s note: The author changed the abbreviation for “Go Big or Go Home” from the common GBGH to GoBoGoH for illustrative purposes.