The (surprising) truth about early-stage start-up valuation
You’ll now play equal game with investors
“How to valuate my early-stage start-up?” is a question I get asked a lot, as a fundraising advisor. Last time? An Argentinian entrepreneur based in Barcelona — hopefully your relatives are fines after what happened, bro — while attending a wedding in South of France lately this summer.
And the answer is (surprisingly) simpler than what you (might) think it is.
The typical (toxic) early-stage valuation talk
- Entrepreneur: “My startup will soon reach XYZ, so we’ll valuate it as if we’ve already achieved XYZ.
- Investor: “Your startup has only achieved ABC, so we’ll valuate it at ABC.”
XYZ is probably too high, while ABC is definitely too low, both to your ego and (more importantly) to your cap. table (i.e. your ability to raise additional rounds).
Here is how to calculate (or justify) your pre-money valuation.
You already know that: forget everything you learned in college about valuating a business.
Secondly, no magic formula.
Thirdly, your start-up valuation will end-up being the result of the three following elements:
1. The amount you raise (must equal 12 to 18 month of cash-burn)
It will take you more or less 12 month to reach your next big milestone, plus it’ll take 6 additional months to raise a new round, totaling 18 month. Don’t forget that your monthly burn-rate will likely increase over that 18-month period of time.
2. The ownership level investors will receive in exchange for their investment.
A sound range of dilution (i.e. what you give to investors post-money) seems (as observed both in Europe & in the US) to be 10% to 25%, for a seed or series-A round. Anything above 25% would be considered as highly unfavorable to the founders. Anything below 10% (again for a 18-month run rate) would show a high level of…
3.… Deal competition.
Are investors racing to your door, or are you facing one lonely/shark-ish investor willing to jump in? Deal competition will determine where you’ll stand in the 10% to 25% dilution range.
Wait. Did I ever mention about your market, about your product, about your team? No. Because these are determining whether the investor is investing or not, and not your price.
Pro-tip: Don’t let the Investor trigger first. Announce a pre-money valuation that is close enough to the 10% range. Indeed, over the negotiations your valuation will likely go south, better to start from a high point then.
Example
You’ve built a monthly cash-flow forecast covering your ambitious expansion plan over the next 3 years. Out of it is your coming 18-month cash burn of €800k:
- low-end pre-money valuation (25% to Investors): €800k / 25% - €800k = €2.4M
- high-end pre-money valuation (10% to Investors): €800k / 10% - €800k = €7.2M
Regardless of your product, market, team — you name it — your pre-money valuation will end up somewhere between €2.5M and €7.2M when raising €800k.
Feel free to make it clap, if you learnt something :).
