The Art vs Science of Pre-Seed Valuations
After countless meetings with highly ambitious founders in the European ecosystems, certain patterns manifest themselves that can remain obscure to first-time founders especially. Most notably, the incessant mental juggling of pricing your first investment round. When you are focused on building your company and materializing your broader vision, it can often feel mundane and taxing to spend time on finding a valuation that can drive you forward, while also making your new investors happy.
While there are several great resources to help with Seed and Series A valuations (Mark Suster has written extensively on this), pre-seed valuations remain more opaque, especially from the perspective of European / Nordic founders.
When raising your seed and later rounds, there will always be a valuation precedent and usually more data to settle on a valuation. However, as the pre-seed round is often the first external investment in your company’s life, the valuation is likely to derive from seemingly arbitrary sources.
However, while trying to find a method to the madness you may ask yourself the following questions, in order to clarify some of the most vital points to negotiating your pre-seed valuation.
1. How much money do we need?
While there’s no right or wrong answer here, it is advisable to raise just enough capital to get you to the most consequential initial milestones, with some cushion time before you need to go out and raise again. With some meticulous expense budgeting and contingency planning, you should be able to get an idea of the monthly burn rate you think is appropriate to reach your most vital KPIs. As a caveat here, be mindful of the fact that most projections related to revenues at pre-seed will be approximations at best, if not flat out wrong. Hence, don’t rely on projected revenue growth to balance out your burn rate.
Once you decide on an appropriate range, model some different scenarios, in which you simply multiply this burn rate by 12–18 months and compare this to the dilution level you feel comfortable with. It’s advisable to aim for 10% — 20% (anything over 25% at pre-seed and you may risk a Russ Hanneman situation)
As a word of caution before proceeding, it is highly inadvisable to initiate your pre-seed round by asking for significantly more money than you actually need. As a first time founder, investor FOMO can be your best friend. Hence, setting out to raise €800K from the get-go (when in reality you only need €500K to hit you key KPIs) can turn off potential angels or micro VCs who hear you only have €400K (50%) of the round committed. As a founder, you may have a far stronger bargaining chip if you can state that 80% of the round is already committed (from the hypothetical €500K you actually need). If you see more demand than expected, you can always opt in to raising more than planned (another caveat to this later on).
2. What does the fundraising market look like?
The market based valuation method can often feel entirely subjective, yet this is an important point to consider when you want to value your company and negotiate with potential investors. To clarify this, we can draw an analogy to the real estate world.
When you want to sell your house, the asking price is rarely the final selling price and every house on the market is essentially unique. What you can do in this case, is price your property according to comparable houses in your neighborhood and find out what similar properties have sold for recently. If you have bought another house and you’re now eager to get rid of the old one, you’ll also have less bargaining chips to utilize.
The team at Seedcamp describe this phenomenon in the following terms:
“the biggest determinant of your startup’s value are the market forces of the industry & sector in which it plays, which include the balance (or imbalance) between demand and supply of money, the recency and size of recent exits, the willingness for an investor to pay a premium to get into a deal, and the level of desperation of the entrepreneur looking for money.”
A caveat to this valuation approach, as alluded to earlier, is that most fundraising data at the pre-seed stage is kept private. This makes it difficult to find benchmarks, thus perpetuating the obscurity for first time founders. Investors and experienced founders with a broader market overview can give a helping hand here (if you’re a Nordic founder, we’re more than happy to give some friendly pointers on this at Futuristic).
You may find yourself in a situation where the market (i.e your potential investors) is offering a pre-money valuation substantially higher than your closest counterparts. While it can feel counterintuitive to show skepticism in this kind of situation, be wary of the fact that you’ll be setting a much higher bar for yourself. If you fail to outgrow this valuation and reach the right KPIs, you may risk having a down-round at your seed (a significant signaling risk that’s hard to bounce back from).
3. Do we have the traction and data to back us up?
In most pre-seed companies the answer to this questions is no. However, if you do have demonstrable traction prior to your pre-seed round, you may use this as leverage to justify a more competitive valuation (given you are cautious of the points made above).
In case you do have substantial data to aid you in setting a pre-seed valuation, metrics such as MRR and GMV multiples can help you lay the foundation for your negotiation with investors. @avoltapartners has collected past European valuation / sales multiples (EV/Sales) for different sectors, which may serve as a broad guideline for this valuation method.
Overall, setting a pre-seed valuation is essentially a balance between art and science. Data and metrics can help you, but the negotiation with investors in the early days is likely to be swayed by market sentiment and a holistic, yet subjective, assessment of your founding team. As mentioned above, it is advisable to initiate your fundraise by knowing how much money you need to reach your first milestones, while ensuring that you can create momentum amongst investors. Additionally, if you end up with more demand that you planned (which is a good problem to have), ensure that you don’t set an unrealistic benchmark for yourself, by raising at a valuation higher than what you can outgrow before your next round.