Is Your Startup Valuation Too High?
10 tips to set the right valuation
High valuations or better yet unrealistic valuations are the underlying cause of a bubble.
However, valuations are always just opinions and agreements, they always come down to what the market is willing to pay.
How do you find out, then, if your startup valuation is too high?
A realistic valuation is based on an honest and objective look at your business’ weaknesses and strengths.
Check your valuation process and outcome against these 10 points and make sure you are ready for investment talks and negotiations.
What to take into account for your startup valuation?
1| Realistic projections
Valuation is commonly based on financial projections and growth. To obtain a reliable valuation estimate, your projected growth rate should be achievable- for instance, the growth rate should not exceed the overall growth of the economy that you are in.
2| Market conditions
Always keep a close eye on the economic conditions. Startup valuations hit an all-time-high in 2015. So for a reasonable comparison of startup valuations you could look up startup data in 2013 says Elizabeth Krane from MergeLane.
In the same way, make sure you use the financial information that comparables (similar companies) disclosed in the appropriate funding rounds. Similar companies should be identified by stage of development, geography and business model.
3| Intangible assets
Investors commonly value startups based on the strength of their entrepreneurial team, the product, and the market. If your company is pre-revenue, then emphasize the product or the market potential, play on your strengths and acknowledge your weaknesses.
Investors tend to highly value previous entrepreneurial experience. If you have been a founder before or you have strong expertise in your field, make sure to capture it in your valuation.
4| Your story
Valuation is just your opinion of what your business is worth today. The financials projections and the market research for comparables are your argumentation. But they don’t stand on their own. The background, the context behind these numbers is pivotal. A good story is the basis for a good valuation. Your startup story has to be possible, plausible and probable.
Numbers are just numbers. In the end, they need to be supported by a good story.
5| Good presentation
Present your valuation clearly. Display and underline the value drivers and your assumptions. A good valuation is not the one that calculates the perfect number, is the one that shapes the discussion in an open and constructive way, and that allows each party to understand that this is a win-win deal.
6| Future proof
Startup valuation is not only useful when it comes to fundraising. If calculated in a reliable way, your valuation can turn into a metric to use when tracking your progress and growth.
Your valuation calculation should be repeatable. Try to always use the same methodologies even if the assumptions behind your financials or your strategy are changing as this will create a useful historic benchmark.
7| How much capital do you need
In your valuation, take into account the capital that you need to. Generally, you should account for at least 18 months of operations until you need to raise more.
To estimate the amount you need, take into account any planned product releases or hires. Also consider the current burn rate of the company, and the time it will take to achieve revenues.
8| Future valuation for subsequent funding rounds
The valuations of future funding rounds determine how much equity founders early investors retain when an exit comes. It is useful to reverse the process and start from the amount of shares the founding team would like to keep and then calculate the current valuation as well as project the numbers for future rounds.
This means you will consider and model your dilution in future funding rounds. Mark Suster — partner in Upfront VC, explains the details of the effects of dilution on the founders in his post Understanding How Dilution Affects You At A Startup.
9| Ranges for your valuation
Valuation often is the deal breaker of investor negotiations. Come up with a range of outcomes that you are comfortable with and present the range instead of a fixed number. That way you signal the investor that you are knowledgeable about the value of your startup but you are also open to negotiate.
10| The clauses of the deal
Consider the terms and clauses of the deal for your funding round as they could affect the valuation. For instance, venture capital funds often include liquidation preferences in their investment contracts. Liquidation preferences give investors the right to be paid ahead of other parties. This lowers the risk for investors potentially allowing you to negotiate a higher valuation. In the end, valuation is only a part of an investment deal, and should be considered and negotiated together with all other clauses.
Calculating the fair value of a business is tricky and always involves research and, later on, negotiation.
Always keep in mind that every funding round is in the end a partnership with people that are going to stick with the company for many years. Startup valuation and more in general the investment process are finalized to a deal. The deal should be fair and a win-win to both parties. The outcome you are looking forward is always the excitement of forming a partnership that is going to change the world.