The infamous V word
Valuation and deciding what your business is worth is the most asked question in the start up community – and one of the most confusing aspect of raising investment. And unsurprisingly, many pitches fail due to wild and unjustifiable valuations that usually alienate potential investors. But how do you even begin to value a pre-revenue venture and justify those numbers to investors? And how much equity should you be giving away?
When building your pitch deck, you’ll need to make three key decisions:
1) How much money should you raise?
2) What percentage of the company should you sell?
3) What company valuation should you use?
How much money should you raise?
Typically, the amount of money you want to raise will be influenced by your company burn rate or runway. This is the amount of money you will need for your company to survive and this is typically 18-24 months (ideally 24 months due to the ongoing pandemic).
The reason for a 12-18 month runway is that realistically you’ll need to be on the fundraising trail six months before you’ll have new money in the bank, and you’ll need to show growth between now and then to get new investors interested. Any shorter than 12 months’ runway and it’s going to be hard to hit key milestones or show any real traction which means you are going to be unable to justify your next round valuation. It’s called a runway for a reason – if you don’t have lift off before you reach the end, things will come to a sudden stop!
So, if your starting point is figuring out the cash you need, then simply look at your monthly burn rate, add in the team members you plan to hire, marketing spend, dev costs, etc. and then look at your monthly burn rate again. Now multiply this by the number of month’s runway you need. Remember to factor in a buffer for the unknown as anything can happen and usually does in startup land!At this point, it’s important to remember, that although you have used the above as the calculation, funding your monthly burn isn’t the message your investors want to hear. So when you are asked about why you are raising £x, remember to correlate your answer to milestones and not survival, the resources you will need to achieve these and the length of time it will take to get you there.
What percentage of the company should you sell?
Dragon’s Den is a really great show but in the real world, equity investment doesn’t quite work like that!
The general rule of thumb for angel/seed stage rounds is that founders should sell between 10% and 20% of the equity in the company. These parameters weren’t plucked out of thin air, they’re based on what an early equity investor is looking for in terms of return. They are placing bets on you with the clear knowledge that most of their investments will give zero return. They are exposed to a high-risk/high potential scenario and will likely want a decent slice of equity to get a meaningful return if things go well (and also to have a meaningful level of influence and control of key company decisions if they don’t.) The sweet spot is 15% – So if you’re thinking of giving away 30%, or you have an investor asking for 30%, think very carefully about it. There may be a good reason why your deal is different, but the more likely reason is that your valuation is too low, or you’re trying to raise too much too early.
If you were to ask different VCs, they’re likely to come up with a wide variety of responses, including:
- Pitch us a number, if you’re ballsy enough and can justify that valuation based on your product vision, and you and your team’s ability to deliver it, great, we’re in!
- The biggest determinants of your startup’s value are the market forces of the industry and 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. So, basically lots of words to justify a gut feeling.
- Go to Crunchbase, search your nearest competitor, mirror their raise history and take your valuation up or down depending on whether you are pre or post revenue, pre or post launch.
- Multiply the amount you want to raise by 3 or 4 to get the valuation.
Some VCs are led by their head, others by the heart. Either way, there’s no substitute for a data-driven decision, and thanks to available data showing what actually happens across a range of funding round sizes, you’re now well placed to not just come up with a number, but justify it.
What company valuation should you use?
Analysis of UK deal data reveals distinct funding patterns that highlights staged valuation bands. This might not accurately represent your startup environment if you’re outside the UK, but at least this will give you an idea of what’s going on in Europe and outside the US:
You’re looking to raise £50K to £100K to get your idea off the ground.
You’ve spent a year building the product with your co-founders, probably not paying yourselves a salary, plus you’ve invested £50K of your own money/time in the project. You’re close to launching, you now want to raise money for that last mile of product development and for marketing.
You’ve launched (congrats!) and you’re seeing good signs of early traction, enough to get investors excited. You have revenue plans, but nothing to show yet.
Unlike Silicon Valley, where the vision of being a unicorn is often enough to get investors interested, UK investors (and probably others outside the US) like to see revenue or at least the promise of imminent revenue. Conservative or sensible? Probably both, but either way if you’re not showing revenue getting funding in the UK beyond Prototype stage is going to be tough. Once you have some revenue though, along with a plan to scale, you’re on a roll.
To get to this point, you need to have figured out product/market fit, proof of repeatable business, and large market demand provable by data, a clear path to scale and new business acquisition, and have identified customer acquisition cost and customer lifetime value. You’ll know when you get there. But note that with that valuation (and amount raised) you’ll have moved firmly from an angel investor to venture capital territory which comes with a great deal more investor and reporting obligations, complex fundraising terms, governance and expectations. Something to note before hopping to the top table too soon.
Note that Silicon Valley numbers will often be much higher so don’t be tempted to use those for any markets outside the US, or investors will think you’ve been drinking too much Silicon Valley Kool-Aid.
Ultimately, your company valuation is whatever you and your investors agree it is. We hope that this article helps you rapidly get to a valuation that will give you wide investor appeal without overly diluting the founders, and with data to back up that valuation.
Article credit: SeedLegals