A Beginner VC’s Guide to Startup Valuation
Making Dollars and Sense of VC-Backed Startups
Introduction
Much has been made of valuation in startups. With the explosion of tech companies that are valued in the billions (aka “unicorns”), VC investors have scrambled for newer and better ways to know how much to invest. While there are a number of books that are heavy on advanced valuation methods and technical terminology, I will try to simplify a bit and explain in plain terms how venture capital firms value startups, and also give an overview of the funding process.
Valuation at the Seed Stage
Investors at the seed stage are most often friends and family, but there are also professional angel investors (I’ve already mentioned Peter Rose) and angel investment groups (such as New York Angels) who will exchange money for equity in the company. Discounted cash flow (DCF) valuation is an option (likely using a very high discount rate) but trying to forecast line items and future free cash flows of a startup can seem like anyone’s guess.
Before money is invested, seed investors need to agree on the valuation. This is called the pre-money valuation at the seed round. This could perhaps be the most difficult stage to value the company.
