Pre Money Valuation
The valuation of your startup is key as it determines
how much of the company you retain and the percentage
ownership by the investor. At the outset it is important
to remember that it will be much better to own a smaller
percentage of a large success than a large percent of
a startup that doesn't get off the ground.
This article addresses a few methods of early stage company
valuations, but before proceeding further, here are the
definitions of a few key terms:
Valuation - a general term describing how much your business
is worth to an investor.
Pre-money valuation - the valuation of your startup prior
to the VC actually investing capital in the business.
This amount is negotiated between the VC and startup (usually
with the assistance of counsel) and may be based on several
Post-money valuation - this is the total amount of the
pre-money valuation plus the actual investment made in
the startup by the VC.
VC ownership percentage (or "cost of capital")
- this percentage is the amount of the actual investment
divided by the post-money valuation. The startup retains
the balance. Over subsequent rounds of funding, which
also include new valuation assessments, the startup's
percentages are likely to "dilute".
Cap table (short for "capitalization table")
- a summary spreadsheet reflecting the ownership by the
various parties in this negotiation. Cap tables typically
reflect pre- and post-money ownership for initial financing
and forecasted subsequent rounds anticipated to achieve
"Hair on the deal" - VC lingo describing undesirable
factors surrounding early stage investors in the startup,
typically by friends, family or angels. Often pre first-round
"angel" or "family and friends" funding
will attach a valuation on the startup that makes subsequent
fundings undesirable to a VC. An alternative to avoid
this problem is to seek "bridge" funding that
takes the form of debt convertible to the first round,
or "Series A" valuation terms, and may also
include additional "warrants" in consideration
for this early stage funding.
Term sheet - this is the document issued by the VC firm
for startups they wish to fund. The term sheet includes
much information, including proposed valuation and actual
funding amounts. The help of experienced counsel will
be good for understanding and negotiating the terms of
the offer from the VC.
Variations in Value
Determining and discussing valuation is a delicate matter.
Should your initial meeting with a VC go well, they may
ask you this question toward the close of your meeting
time. If a VC inquires about your "valuation,"
they are seeking to know if you are an informed entrepreneur
about the relative value of your startup.
The term relative is key. Think of early stage startup
valuations as similar to the relative "comps"
on real estate. VC's are interested in determining a valuation
that is comparable to other company fundings in your marketplace.
Their underlying goal is to negotiate the most favorable
ownership percentage for the investment capital they intend
to place in the venture. Try not to be coy, but avoid
answering with a specific number if possible. The VC is
most likely interested in your thought process used to
arrive at a valuation over a specific number. In many
cases you might suggest a range, for instance, a $6-7m
pre-money valuation on a $3m investment for a post-money
of $9-10m. In any case, flexibility is the key message
you want to convey -- along with the fact that your primary
interest is launching the startup about which you are
passionate, and while changing the world through this
startup you also intend to make a great deal of money
for yourself and for the investor. The ideal scenario
is that both parties exit the negotiation believing that
the deal is fair, although they would have both liked
to have received more value on their side of the deal.
How to Determine Your Startup's Valuation
There are several ways to determine valuation for your
startup. Know that with most of these methods may be difficult
to base on objective facts. At the end of the day you
may need to rely on the fairness of your investor to propose
a valuation that is consistent with other known "comps"
and also consistent with other relative valuations in
his/her existing portfolio.
A no-cost method to research and potentially establish
valuation is by searching for similar companies that have
recently received funding via online information sites.
While the amount of funding may be readily available,
the pre-money valuation may not be. Another method is
to use a professional valuation firm.
Another, possibly more justifiable method is to use a
professional valuation firm like Venture One. This firm
offers a "Comparable Valuations Report" for
a fee of $1,295.00 that specifically addresses your company's
market space and locates comparable business fundings
and valuations that you may use in your negotiations with
a VC firm. Having said that, it is not advisable to enter
a term sheet negotiation by waving a Venture One report
in front of a VC and stating that this is the valuation
you expect. Rather you should use this tool as backup
to substantiate your position as the negotiations unfold.
On a final note, traditional methods of deriving a startup
company's valuation through discounted cash flow (DCF)
models, or assigning value to individual key contributors
or forecasted sales and multiplying by a factor are not
highly weighted, or may even be dismissed by the VC. However,
check with your legal counsel about the value of assessing
the impact on valuation for the intellectual property
owned and developed by the startup.
Technology Toolbox, Inc.