How do you value an early stage company?
It might sound overly simplistic, but I tend to think that this is something that the market decides – the valuation is whatever an investor will offer and whatever a founder will stomach, and hopefully there is some overlap!
For what it’s worth, these are my rules of thumb for founders, when I’m asked about valuation (hopefully publishing these doesn’t come back to bite):
- Expect to dilute between 20-30% per round (there are lots of recent data points which support this: all of the rounds we’ve done at Vend, and all but the most recent Xero round have been in that range, for e.g.)
- Plan to raise enough to cover 12-18 months worth of expenses (and there should be a good plan which estimates what these are likely to be!)
Solving the equation given those two constraints gives a valuation range to start a conversation with.
Then the softer, but ultimately much more important questions:
- Choose the larger investors you want to work with, and work with them to agree terms that you’re both happy with, then fill in whatever is left with smaller investors (nearly everybody does this in the reverse order, which is a mistake)
- Make sure that the bigger investors are putting enough cash in, and getting enough of a percentage in return, such that they care about the venture and will invest their time and energy and networks into making a success in the future
It gets more complicated if you already have customers and revenue and a growth trajectory, since that gives some basis to start to be valued on fundamentals (e.g. 15-20x annualised revenue are numbers which get thrown around for SaaS businesses), but at an early-stage when the numbers are small that often ends up being in the range I mentioned above anyway. Be aware that numbers can easily mess up a good story!
The other thing which can influence all of this is FOMO, if you’re growing really fast and/or there are external factors motivating the investor to do the deal, you possibly get away with a much smaller dilution (e.g. the most recent Xero round in 2013 was ~8%). The risk with this is you get an investor who needs you to continue to grow very fast to justify their price, which can create some pressures which are not useful.
Finally, try not to get bogged down in this, whether you’re an investor or a founder. At the end of the day neither side wins because they eked the last percentage point of dilution out of a funding round negotiation, they win by working together to build a fast-growing ass-kicking name-taking business. In the not too distant future whatever valuation you agree now is likely to look way too high (because the company is dead and therefor worthless) or way too low (because it became a big success).
So, don’t pretend too hard to be something you’re not and don’t die in the ditch.