Updated: Jul 2, 2019
You’ve probably heard of the equity analyst, whose job it is to closely track a public company like any defender would Lionel Messi. She does some number crunching, probably utilising an EBITDA or other industry multiple and comes up with a fair value for the company. Things don’t work that way in the startup world. In fact, there’s no single scientific way to put a value on a startup, especially in the early pre-revenue days. But there are some considerations to take into account if you are fundraising, because your funding round will be based on a valuation. So, here’s how to value your startup:
Startup valuation is an art
If you are fundraising, the first thing to think about is how much money you want to raise. Second, think about how much equity in your company you are comfortable giving away to raise the money. This should give you a first glance at what a potential valuation could look like. Market forces, such as supply, demand, how “hot” your industry is, and so on, will also have an influence on what investors might be willing to pay. So, what do you do next?
Decide how much money you want to raise
As a general rule of thumb, you should be aiming to raise enough money to see you through a 12 – 18 month runway during your first raise. The reason for this is realistically, you’ll be on the fundraising trail for at least 6 months before you get any new money in the bank and you’ll need to show decent growth and traction between now and then to get investors interested. A runway shorter than 12 months won’t give you enough time to show real traction to justify your next raise, so don’t be unrealistic about how much time you need.
To determine how much money you should raise, you need to work out your burn rate, which looks at things like cost to hire team members, marketing expense, office rent, development costs etc. For example, if your monthly burn rate is $10,000, and you’re looking to have an 18-month runway, then you’ll need to raise $180,000 in your funding round.
At this point, it’s important to remember that while you have used the above method to determine your funding amount, this isn’t how you should communicate things to investors. Rather, you should frame the conversation in the context of what KPIs or milestones you are looking to achieve over the runway period.
Decide how much of the company you want to sell
There are many opinions on how much of your company you should sell in a given funding round, but as a rule of thumb, you should be selling between 10% - 20% of your company in a seed round. These numbers are based on what the average seed stage investor is looking for in terms of investment returns. Seed stage investors place bets on companies, with the knowledge that a majority of these will fail, so they’d be looking for a decent level of return should things go well. They’d also want a meaningful level of influence or control of the decision-making process in the business to “protect” their investment.
So, if you have an investor wanting 30%+ of your startup in a seed round, that means you are either looking to raise too much money, or the investor is asking for too much.
How to value your startup?
Valuation by stage
Again, these are “rule of thumb” numbers but the further your company has progressed along a development pathway, the lower its risk and the higher its value. A valuation-by-stage model might look something like this:
Valuation: $250,000 - $500,000. You have an interesting idea, a business plan and a founding team to execute on it. At this stage, you might be looking to raise between $50,000 - $100,000 to get things going. At MBTN Startup School, we help you bring your idea to life in just 4 weeks.
Prototype/ MVP Stage
Valuation: $500,000 - $1,000,000. At this stage, you’ve spent a few months validating your idea, you have a working prototype ready, with initial users using the product and giving you very valuable feedback.
Valuation: $1,000,000 - $2,000,000. Here, you’re ready to announce your product to the world and begin taking on users beyond your initial test group. This is also when your marketing spend ramps up, and you begin to transition into customer/ user acquisition mode.
Valuation: $2,000,000 - $3,000,000. As you begin to generate revenue and acquire more users/ customers for your product, you’ll be able to raise fresh capital at even higher valuations.
Valuation: $3,000,000+. To get here, you need to have achieved product market fit, with a good number of repeat business customers, and large market demand, with data to back it. You should also have figured out things like your Customer Acquisition Cost, Customer Lifetime Value, and have a clear path to scale.
Join Y Combinator, Techstars or some other reputable accelerator
When you join Y Combinator (YC), they invest $150k in your startup for 7% equity, using a legal structure known as a post money SAFE. We won’t go into the legal details here, but you can sleep easy knowing that by graduating from YC, it won’t be unreasonable to have funding conversations with investors at a valuation of at least $10m. You only need to look into the funding rounds of YC startups like kobo360, Paystack, Flutterwave for evidence of impressive valuations. The MBTN Accelerator is another option to look into, for African startups looking to scale up.
The comparables method
Find out what valuation similar companies in your industry and geography have fundraised at to get an idea of how much investors are willing to pay. Remember, your startup is only worth what investors are willing to pay, so what better way to figure this out than listening to what is happening in the market?
It's easy to get caught up in the excitement of how to value your startup. Remember, raising money is cool, but you’ll also have to deliver on the expectations of investors. Also, be careful about overvaluing your startup with faulty assumptions; it will only make your life more difficult if your investors have rights, such as positions on the company's board. You don’t want your investors kicking you out of your own company now, do you?