How to Calculate Your Seed-Stage Startup Valuation
How do I value my company?
It’s a question we get asked a lot by founders of pre-seed and seed stage startups. Valuation is a critical number to get right, but it’s unclear to most founders how to calculate the value of their own companies. That is understandable. The valuation process is opaque due to lack of objective data and fraught with misconceptions about incentives, dilution, ownership, and unknown market predictions.
Here’s a model for how startups should calculate their own valuation so that they have an informed opinion when going into meetings with potential investors.
Start with Your Exit and Work Backwards
First, you need to think about the end goal. Unless you’re in Silicon Valley, it’s statistically unlikely that your SaaS company is going to be a unicorn. A realistic and successful exit will be an acquisition for $100M or less in 5 to 7 years.
The other way to assess this regardless of your geography is top down by determining what the total addressable market is for your company. Not the total possible market if you get 100% customer penetration and everyone adopts your product — rather the market you aim to capture. If it’s not clear how this is going to be a billion dollar plus company, you should price based on a conservative estimate — likely that sub $100M number.
This is the exit investors will expect, and they’ll be doing the same math as you are when setting valuations on their end.
Understand the Multipliers
All my advice rests on two commonly accepted multipliers.
The first is that investors want at least a 3x return. For every dollar invested, the minimum acceptable return at the next milestone is three dollars. Obviously, every investor hopes for a much larger payoff, but this is an expectation that is both ambitious and based on your plan should be achievable. We know that kind of return is life-changing for an entrepreneur. This number is important because it means for every round you raise, investors will expect the valuation to go up by at least three times the previous round.
The second multiplier is that the post-money valuation of a SaaS company should be roughly between 5 and 15 times the current ARR, annual recurring revenue, depending on your market and growth. Since we generally use ARR as the number one measurement of a company’s success, this is an easy way to ballpark valuation. Five to fifteen is a big range, but it’s a good place to start.
Base Your Goal for 18–24 Months on your ARR
Now, you’re going to dive into the next 18–24 months — the average length of time between raising rounds — and decide what you want to accomplish in that timeline. This could be raising a Series A, hitting product market fit, going from prototype to MVP, securing initial customers, or a number of other metrics. Then, you’ll tie that to your ARR.
Companies will be a strong candidate for raising a Series A when they’ve achieved at least $1M in ARR. So it is logical that if you’re raising a seed round right now, you’ll want to make sure you’re on track to hit $1M ARR in the next two years.
When you’re taking investment dollars, you have to work backwards from a future goal to set the present valuation. It’s sort of counter intuitive, but it makes sense when you remember the whole point of investments is to bet on a future outcome.
Do the Math
So, you’ve got your 18 to 24 month goal and you’ve got the relevant multipliers. Now you can put it all together to come up with your present valuation. Start with your target ARR for your next raise, multiply that by 5 to 15 for your target valuation for that raise, divide that number by 3 and voila — you’ve got your target post-money valuation for this round.
For example, if your company is currently pre-revenue and you hope to raise a Series A in 18–24 months, you’ll need to achieve at least $1M ARR by then, which would make your target Series A valuation between $5M and $15M. Then, you’ll divide by three to get your valuation for this round. That sets you up for a seed round with a post-money valuation of up to $5 million. You’re well positioned to raise $1 million on a $3M, $4M, or $5M post-money valuation, giving your investors between 20% and 33% ownership.
If you’re earlier and only raising a pre-seed round, you can do another round of dividing. Take your target seed valuation — say, $3M — and again divide that by 3 to get a pre-seed post-money valuation of $1M.
Plan for the Best, Prepare for the Worst
Besides changing the world with disruptive technology, a major motivator is the creation of wealth. For some, wealth means $1M and for others it means $1B. Regardless of your definition, by setting your initial pre-seed or seed-stage valuation too high, you are limiting the potential scenarios to create personal wealth on the lower quartile of that range.
Investors have investment mandates and expectations around outcomes. If you raise your first $1–2M round at a $10M post-money valuation, assuming no more dilution, the investor won’t be excited unless the company exits for at least $100M — 10 times the initial valuation — and would be disappointed if the company exits for less than $30M.
If you knock it out of the park and grow rapidly over the 18–24 months post-investment and hit your metrics, then all is well. The investor gets a markup or real return and everyone is happy.
But, this rosy scenario is most likely not what will happen. Plan for the best, prepare for the worst. Set ambitious goals and give yourself room, resources, and time to hit them.
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