Business Lawyers in Columbus, Ohio
By Drew Stevens - May 22, 2019 - Startups + VC
One of the more challenging aspects of growing your startup may be valuation. If you’re a first-time founder, nothing can be more frustrating than wading through jargon and buzzwords, searching for simple answers on startup valuation.
Business Startup Attorney
In this post, we’ll break down some of the essential concepts you’ll need to understand, such as pre-money and post-money valuations, and some of the key factors that will impact your startup valuation.
For you founders that have been diligently researching accounting and company valuation options, you’ve probably seen some of the major methods such as discounted cash flow and multiples. The good news is that these don’t apply to you. The bad news is that these don’t apply to you.
Sometimes a point of consternation for both startup founders and investors, traditional accounting methods can provide proven clarity for more mature and established companies, but these can have little applicability to early stage companies. Startups in the idea or very early development stage generate little revenue and may only have signed up a handful of customers.
Attempting to base your company’s worth on operating income, EBITDA, or cash flow won’t get you very far.
In short, the simple answer for how to value a startup is this: your startup’s valuation is whatever number both the founders and the investors agree on.
Especially for seed and early stage companies, your first valuation likely won’t be based on financials, perhaps not even on reality. Hence, whatever number a consensus arrives at is going to be your initial valuation.
We’ve all been at a pitch competition or seen certain television programs where the intrepid founders declare confidently that they’re seeking an investment of $100,000 in exchange for 10% of the company. What exactly does this mean?
When you say you’re seeking $100K for 10%, this translates to you saying your post-money valuation is $1 million. Your pre-money valuation is therefore $900,000. For those of you who like some easy math, here’s a simple formula for calculating your post-money valuation:
Post-money valuation = raise amount / the equity percentage, expressed as a decimal
For example, $1,000,000 post-money valuation = $100,000 / .10
Great, you may say, you now understand pre and post-money, but you still don’t understand how you’re supposed to arrive at your pre-money valuation when presenting to angels or venture capital firms. While traditional accounting methods might not be very helpful, a great source of information can be market comps and recent exits.
By comps, we mean comparables. If you’re a startup in Columbus, you may get a general idea of looking at numbers for startups in your industry and sector.
A word of caution: if you’re in the Midwest, comparing yourself to a Silicon Valley or New York startup might lead you to inflated number or figures that aren’t as applicable to you. Try and hone your research to startups based in Columbus and other Midwest startup-friendly cities such as Chicago, Minneapolis, Detroit, and St. Louis.
Once you’ve found startups similar to yours in an applicable geographic area, start analyzing the line-by-line differences between your comps and your startup. This entails looking at a number of factors, including the following:
-market size, market share, and overall exit potential
-the degree to which how quickly and efficiently your business model can scale
-whether the founders have significant startup and exit experience and their overall involvement – are some of the founders all-in and working full time on the startup?
-what stage is your product or service in – is there a prototype? Are you in alpha or beta testing?
-what stage are you in terms of customer development and retention? Are you signing up customers? Are they coming back and repeatedly using your product, software, or app?
-what does your board of directors look like? Do you have any notable members?
-what steps have you taken to firm up, define, and protect your intellectual property?
-how do you compare to your competition? What sets you apart? Is someone else first to market?
By starting with comps, and analyzing some of these factors, you should be able to at least get a general idea of what is a reasonable range for your pre-money valuation and approaching angels and venture capitalists.
Negotiating term sheets, stock purchase agreements, and working through a valuation can be intimidating for startup founders. If you feel that we can assist you with your startup and venture capital needs, do not hesitate to contact us today.