How Do You Do a Valuation for Raising Startup Capital?
Here are a number of ways to come up with a valuation for the the purpose of raising your first round of outside financing. The thing to understand is that there isn’t any one way that everyone agrees on. In reality there are several different valuation methods. On top of that, everyone has their own unique spin on each one.
First things first, understand the meaning of the terms pre-money and post-money valuations. If your startup can justify a valuation of $5 million to investors before they invest, then that is its pre-money valuation. It’s the value the founders have been able to create on their own. If the company is seeking $5 million in startup capital and gets it, then its post-money valuation is the sum of the pre-money valuation plus the cash, or $10 million.
Let’s start off with this short video by a finance prof.
Here are some additional methods for coming up with a valuation for a startup company. Legendary angel investor Bill Payne describes four popular methods for valuing pre-revenue companies. He believes as he should that entrepreneurial projections are “too imprecise” and optimistic to be useful.
Ian Giddy,a professor at New York University prefers more traditional methods of corporate valuation. Entrepreneurs seeking startup capital need to understand both discounted cash flow and market multiples before committing to a value for their company.
By being able to anticipate which method your investors will use enables you to win a higher valuation and retain a greater ownership percentage of your company after it’s funded.
Here’s the takeaway. Valuations for businesses that have been operating for a few years are based on some semblance of reality. That’s because your start with the company’s actual financial performance over the past three years and derive a valuation from them using a multiple. When it comes to startups, it’s all based on numbers the founders pulled out of their asses. (Pardon my French.) In plain English, the numbers are made up and come down to how attractive the investors find the company and how badly the founders need an injection of cash.