Raising money: what’s the fair valuation of your start-up?

Alain Caffi
Jul 19, 2016 · 5 min read

As an entrepreneur you legitimately have some precise expectation of the valuation of your company/project linked to the global vision you have of your business and then you may be confronted with Business Angels or VCs coming back to you with what looks like short sighted disappointing numbers. The earlier stage your company is, the more likely you are to face a significant gap in terms of expectations. So how to find some rationale to open a fair negotiation.

As the overall issue is your dilution I would share with you is that the rationale for both parties should simply be:

- On the one hand, what the valuation means in terms of fair sharing of potential gains between Entrepreneurs and Investors?
Does this fair sharing still work in the future taking into account a rough estimate of how much money will be needed in total until the exit?
- On the other hand, how much money is reasonably needed to reach significant milestones, now and later on, and in which time-frame?

So my few tips are the followings

Valuation should be based on a pragmatic analysis of the business

For series A which is Ventech investment sweet spot, conventional valuation methods, such as discounted cash-flow or comparable multiple on Net Result or Ebitda don’t work. So we will typically cross various pragmatic / down to earth methods:

- A first estimate based on sectorial multiples applied to the annual actual revenue run rate or more likely to the revenue run rate expected by the end of the current year. This estimate will be fine-tuned by taking into account the month over month observed growth, the backlog, the seasonality, if any.
- A similar approach applied to the annual budgeted revenues then on the last budgeted month annual run rate to give some perspective to the previous approach and assess its consistency.
- Last but not least the same approach again applied at the exit time to what we could call the expected critical size of revenues the company should reasonably achieve; challenging question… Then this potential future valuation will be divided by a targeted multiple return on equity gain to assess the present valuation.
- In parallel even if there is not such thing as market prices, we will look both at recent similar transactions and other current opportunities when keeping in mind, as we are supposed to keep a cool head in every situation, that valuations could widely fluctuate according to the trendy topics, the economic climate.

Here I have only considered revenues which for young companies are more meaningful in most cases, however the burn-rates during the first years, the time frame to reach the break even and then the likely level of profitability at maturity, are other criteria to play with.
Moreover, the assessment of how much capital will be globally needed is really important, even more, most of the time, than the initial value.

On seed pre-revenues projects, the valuation will be based mostly on the level of development of the project, the proofs of concept if any and of course even more the ability of the team to execute.

All in all, those different approaches will not really lead to a magic absolute number but to a reasonable range of valuation then ultimately will give a sense of the sensitivity of the valuation based on the milestones that should be achieved in a relatively precise time frame.

Right size of financing is key for efficiency

First of all, as a rule of thumb at Ventech we will always advise an Entrepreneur to look for an 18 months financing as a minimum for a seed project and a 2 years financing minimum for a later one. Founders may be tempted to raise several times to take advantage of the development of the project and thus limit their dilution; this especially at the seed stage. We think it’s not worth the risk of not achieving meaningful milestones in due time and slowing down the execution of the plan when keeping the momentum is a key success factor.

The other way round, Entrepreneurs should be cautious if they have the possibility to over-finance their project. Especially for series A+ and even more likely if they work with a placement agent (!) they may be tempted to raise more money than they really need in their plan. To be honest we won’t totally discourage them to take the money if it’s a good deal but then Entrepreneurs should be aware that this could be perverse and so be careful not to burn much more than they would have done if their project had been reasonably financed.

Based on what VENTECH did over the last 5 years and to illustrate my previous 2 points I looked at the round sizes and valuations to try to establish some meaningful ranges but unfortunately the disparities were too huge mainly due to the diversity of projects maturities, sectors, geographies and even time periods… The only metric I found which seemed relevant is the median dilution which came in at roughly 30% both for Seed rounds and A Round keeping in mind that Ventech is in the high end of amount raised especially for Seed (between 1 and 2m€ with few even far above this) as Ventech is targeting projects which can scale internationally. It is also interesting to notice that in most cases the Founders lose the majority at the A stage.

Above all, a Valuation has to be fair

At Ventech we like to invest in post-seed / series A for two main reasons:
- it’s at this stage that we have the highest level of implication in a company
- it’s the perfect time to build a close and trustworthy relationship with entrepreneurs.

This being said, basically entrepreneurs and VCs join forces on a project and will share a long journey; in this sense their initial negotiation on valuation and financing size should build the right basis for their future relationship. So it’s worth taking the time to share on the one hand a strategy / a vision and what we can call an ambition for the project, then on the other hand to agree on what it should globally require by translating this vision into a Business Plan with clear milestones to reach, resources to put in place along the way (people and cash).

That being done, entrepreneurs and VCs should share the same assessment of potential risks and rewards. Their transaction should put the basis for both parties to be fairly treated whatever the outcome, a huge success or a more moderate one, meaning that the valuation of a company should take into consideration as an ultimate goal a fair sharing of the capital gains for everyone to be motivated until the exit time: all valuation approaches should be viewed with the prism of fairness.

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