A SIMPLE STRATEGY FOR VALUATION — How to Value your Seed Stage Startup
I was recently invited to give a private two day seminar to the companies involved with Sanara Ventures, an early stage health-tech investment shop in Israel. One section of the seminar was focused on how pre-revenue founders should answer the question: “What is your valuation”. Below is the first part of the section. Thoughts welcome. Part 2 in the coming days…
At the theoretical level, valuation for any early stage startup, in any sector, involves three main components that founders should consider when approaching investors.
Valuation at the earliest stages, before there are any tangible metrics, is not about revenue projections, DCF, NPV, WACC, etc… These tried and true metrics simply don’t work when there is no traction or actual business operation results. (N.B. — there is still a place for these metrics, even in the earliest stages, but they need to be adapted and adjusted accordingly…)
Instead, valuation is based on a balancing act between Top Down benchmarks, Bottom Up financing needs, and Intangibles.
TOP DOWN BENCHMARKS
VCs and investors have their own thought process when evaluating the worth of a company, like the sector, potential exit multiples for the space, comparables, etc…
These are TOP DOWN estimates.
VCs are constantly tracking data from places like CB Insights, Pitchbook, etc, to gauge benchmarks and trends of valuations for each stage in each sector. They are also going to be looking at where similar companies in the stage have recently received funding — how much and at what valuation.
They know this info inside and out, and founders should have some minimal grasp on these parameters prior to any meeting with investors.
Relevant info to think about includes: median/mean pre-money valuation (per stage/sector), median/mean equity stake (per stage/sector), geography, and valuation trends.
The point is this: for a digital health startup from Finland in seed stage, VCs are already going to have a range in their head regarding valuation, and they are going to be skeptical if a founder throws out a number far outside of that range.
BOTTOM UP ESTIMATES
The bottom up valuation is based no what founders ACTUALLY need for the next milestone.
This is an expense driven analysis tied to a tangible next milestone.
I cannot stress enough how important milestones are, and how frequently I see founders ignore this basic critical aspect of building business.
A brief aside about milestones — Why are milestones relevant?
Founders must properly define their milestones accordingly:
- In the “tangible” future
- Directly related to a stage in the development process
- Actionable with foreseen resources
Back to our story… Founders should track out the expenses they need to reach the next milestone, and add a buffer (contingency) for unknown additional costs.
Then, you know that Seed round investors typically want a 25–35% equity stake (because founders did a bit of top down benchmark analysis) and do some simple math:
As an example, let’s say a startup actually need 1.2M to hit the next milestone. With a 25% contingency and giving away 30% of the company, the bottom-up valuation estimate is $5M. Easy.
INTANGIBLES
And finally there are intangibles.
Intangibles are just that — indefinite — like FOMO around a specific type of tech driver, or hype around a specific sector, or unique track record of founders, etc…
For example, ten years ago Gaming was a huge sector, then Cyber, now Digital health, and the emergence of Ag/Food tech. There was even one quarter back in 2014 when everybody was doing Parking apps… These intangibles will move your valuation up or down accordingly.
Founders need to be aware of all three of these aspects when asked the question: “What Valuation are you thinking?” It is a signal to the VC across the table that you have done your homework about the sector/stage you are in, and also your practical funding needs.
Founders should be able to triangulate between the three as part of their initial pitch to investors, and also as part of ongoing negotiation around terms.
Part 2 will cover putting it all together and how to deal with discrepancies between the three components.
