‘How much is my startup worth?’ is one of those how-long-is-a-piece-of-string questions (which is no help at all), but there are a few guidelines that can help…
Naturally, potential investors and hardy founders will look at startup valuation in opposite ways.
The plucky founder will want to give away as little of the company as equity for as much cash as possible (the highest valuation), thus retaining more for themselves, their co-founders and any future funding rounds.
Meanwhile, the investors will want some meaningful slice of the company, so if things really do take off and the company is worth something in the future, they will get some kind of nice return on their money. As they may invest in several startups knowing most will fail, for each one they do invest in, they will want to see at least 10 times return on their money.
While investing in early stage startups can be fun and exciting, it’s not an asset class that will suit everyone, and is not for the investor’s nest egg. It’s about as risky an investment as you can get. But with risk, comes reward. One hopes.
Maybe, somewhere in there you can do a deal. Maybe not. You may have to speak to dozens of people before you raise a cent. It can take months. It might not happen at all.
But if you are venturing out to get some equity funding, my best advice is ‘be realistic’. That means, don’t go crazy over your valuation and don’t be slap dash. Prepare yourself and practice, practice, practice.
I am assuming we are talking about a brand new, pre-revenue scaleable tech startup with little or no trading history. In WA.
You have an idea, a business plan, maybe a prototype, have set up a company, put in some of your own money, and have something (an app, website, some users) to show for it. But you are otherwise brand spanking new.
Are you really going out with them?
Before worrying about valuation, think carefully WHETHER you need new shareholders at all and WHO you get on board as an equity stakeholder in your business.
Once in, investors tend to hang around (as there are only limited opportunities to get out).
It can be very awkward if – later on – you or they think it’s all been one big mistake. Also, some future investors won’t touch you if you have the wrong people on your share register from the get go. The same goes for co-founders and sometimes employees too. Be careful what you wish for.
You will be assessed by who you associate with, and having investors in your business is about ‘as associated’ as you are going to get in your life.
Like a marriage, it can take a lot of nasty unravelling to undo. Think on’t.
Do you really need money?
Have a long, hard think about how far you can go on your own.
How much further can you go with your own money, or some cash you can cobble together from some kind of early/trial customers, collaborations, R&D tax incentives, Uncle Tom Cobley and all?
Can you even get your customers to fund your business, at least a little bit … maybe even to profitability? By all accounts, that’s the best way.
But let’s say you’ve done all that and exhausted all other avenues. It will just take more money to give this thing the push it needs. Equity fund raising it is.
How to value it?
Simply put, the price of an early stage tech company is whatever the founder is willing to sell a piece for, and whatever someone is willing to pay for that piece.
This is also not very helpful, but it’s true.
It’s a bit like selling your car, or your house. There is only one unique version of the asset, and a limited amount of buyers. But you only need one (or a few) brave buyers, and then the deal could be done.
If you need, say $50K, and are willing to sell 10% of your startup for this investment, and someone is willing to pay you $50K cash that for the stake, then, by definition, your company is valued at $500,000 pre-money.
Pre and Post Money Discussions
The ‘pre-money’ bit means that BEFORE they put the $50K in, your company was worth $500K (as $500K is 10% of $50K).
Note that AFTER they have put it in, it now ALSO has $50K in it, so technically your business is now worth $550,000 (‘post money’). Talking ‘pre-money’ is cleaner and easier to calculate in any valuation discussion. ‘Post money’ gets a bit fiddly.
With your startup now valued at $550K, the new investor does not actually have 10%, they have 9.09%. What was 10% pre-money is now 9.09% post money.
If they wanted 10% post money, then they’d have to put in $55K (which is 11% pre).
If you, as founder, owned 100% of the business beforehand, you now own 90.91% after the transaction. The new issuing of $50K worth of shares has diluted you a little. But you have over 90%, which is almost as good as 100%.
As a wise investor once said to me: “A minority stake investment by an investor is a gift to the founders, as the investor has no power at all!”
With 90%+ ownership, you effectively have complete control, except you now have an investor, who one day hopes will get more than $50K back for their investment, hopefully half a mill or more. That is the point, after all.
So, with the $50K in the bank, you can get on with business and ring every last ounce of value out of that fresh money. The hope is that if used wisely, future valuation will be way more than $500K. In this way, you and your investors’ outcomes are aligned. If they win, you win.
Stuck in the Middle with You
Except, the investment is not liquid (they can’t take it out as cash, as if in a bank) and they can’t borrow against it either (unlike equity in their property investment).
Effectively, it’s stuck in there until there is some ‘liquidity event’ happens, such as the sale of the whole company, an IPO or some new investors come in allowing earlier ones to exit.
This latter eventuality is a rarity. What new investor wants to see their money used by original investors exiting stage right? Unless they want them out of the way, In order to ‘clean up the register’.
Another way of earning on shares is dividends, but I am assuming you are a long way out from profits. Most scaleable tech startups would reinvest any such reserves in order to scale.
So, back to valuation. How do you come up with $500K, or $1M or many millions as the fair dinkum valuation for your early stage tech business?
Assuming the business is a truly scaleable tech startup with a clear defensible position, a significant market to go after and with good founders…
$1 to $500K, from an Idea to a Prototype
If it’s just an idea and a slide deck, you be hard pressed to value yourself more than $500K. That is, if you wanted $100K to build the prototype, then you’d have to sell off at least 20% for that (pre-money).
Would it not be far better to try to cobble together $100K, or whatever you need, or code it yourself, and get to MVP that way, then raise money? Many startups can get to MVP on less than $20K if they are frugal and clever. Startups usually turn to “family, friends and fools” (the 3Fs) in this round. (Hint: don’t get fools.) If you expect your business to be worth a few million over time, why even start with a valuation so low, give away so much for so little and raise money on an idea? Go further.
$500K to $2M, from MVP to paying clients
If you have a MVP/prototype, but are still pre-revenue/launch, or perhaps have a trickle of early sales, then you may be valued in $500K-$2M range.
So if you wanted, say $500K for growth/sales and gain market traction, then you’d be selling off 25%+ for that. Or ~10% for $200K, etc. This would be ‘Seed Angel’ round (pre-Venture Capital) from high net worth investors most likely.
This is perhaps the hardest money to get, as you are still very early, and too small for most VCs. Raising $20K is much easier, finding people who can part with a lazy $50K or $100K each can take time – especially in WA – and most want to see some client revenues/traction before parting with their hard-earned. Catch 22.
$2M+, from commercial sales to scale
If you have launched your product, have paying clients, revenues, growth and traction, you could value yourself more than $2M, and really the sky’s the limit the more of that (and the more time/evidence & unmet potential you have).
The irony is that you may not even need funding when you have grown to this stage. Earlier, it was hard to drum up interest (when you were pre-revenue), yet you needed it. Now, you may not require or want it at all. Agh, the conundrum.
If you are are raising and you’ve been around for a while, have good market share, growth… you will probably be more into standard business valuation metrics such as annual total and growth of sales, net profit, clients, market share, etc… You’d need to know your ‘Cost of Client Acquisition’ numbers really well, as well as ‘Lifetime Value of Client’ etc.. Investors will be all over this. You may then be in VC and Series A territory, so would looking at investment here of at least $500K, probably $1M or several millions.
If you are a WA-based early stage tech startup and have an idea/deck and perhaps an MVP, and think you’re worth $4M or $5M+ then I would have to tell you ‘you’re dreaming’. Not in WA.
That’s not to say you won’t be able to raise money at all on that valuation. There’s always someone out there with more money than sense, and might be persuaded by a slick slide deck and a silver tongue. But even if you did get early stage money at that price, how could you sustain it? How will you be able to build an upside for your investor(s)?
Knowing how risky it is, most investors in early stage ventures are looking for at least a 10x return over time. If the valuation starts too high, that makes the 10x less likely and they may shy away.
Remember, it’s easy to buy things, but when buying your investors are setting the base price expectation from which they will want to see a multiple. The investor can make a profit when they buy, depending on that price.
Finally… it’s MORE than money
Of course, raising funds and valuation depends on what you want to do; how much money you need, what market you are attacking, your track record, what you want to sell it for, and (more importantly) the VALUE the investors bring besides money.
It’s YOUR company remember.
How much do these investors ADD in more ways than money? Can they open doors to your next round? to new clients or partners? Do they have experience commercialising what you are doing? Have they been there and done it before? How have their other investments gone? What are their real motivations for investing? Are they going to be active or passive investors? Involved, but not too much, or just plain annoying? What are their expectations around exits?
If you’re not happy, 100% rock solid happy with a potential investor,then please don’t take their money. Listen to your gut. It’s usually right. Life’s too short. Making the wrong choice is simply not worth it, no matter how much money they throw at you.
AN earlier version of this piece originally appeared on the author’s blog. The opinions expressed are a personal view, and should not be taken to represent those of any employer.