πFounderβs Pocket Guide - Startup Valuation
https://www.icloud.com/notes/0030zyuPGemthCz4Pslca-8XQ
Book Summary - Founderβs Pocket Guide -
Startup Valuation
Key points
Early stage valuation methods
The market comp valuation method (pg 39)
Create a short profile of your startup
Find similar startups with known valuations to use as comps. Refer to Angel.co, CrunchBase.com, News.Ycombinator.com/news, gust.com
Compare your startup to the comp
Adjust the comp valuation for large and obvious differences. Itβs not an exact science, note down how you adjusted.
Extra notes:
use more than 1
this method is most practical in places where there a high density of Angel and VC investment
need to be able to explain how your startup is different considering team, ability to execute, tech and IP, market timing, funding plan
The Berkus valuation method (pg 44)
Avoids relying on the founders financials
Considers these 5 characteristics β¦
Quality of management team
Sound idea
Working prototype
Quality board of directors
Product rollout or sales
For each add $0 to $500k to pre-money valuation
The step up method (pg 45)
Has 10 valuation factors. Builds on Berkus by adding factor related to validating the product or service and founder related factors which are previous exit experience and 1+ founders working FT.
$250k for each factor so a maximum valuation of $2.5M
Rate your startup by tick if they meet the factor confidently
Add up and x $250k
Considerations:
feel free to substitute the factors that you think are more significant to your startup. For example if you have a notable board of directors
some investors will consider some factors as essential. For example some IP, some paying customers
you can issue yourself partial of the $250k
There are no rules!
Risk mitigation valuation method
Assigns dollar values to the accomplishments and validations related to (1) Technology, (2) Market, (3) Execution, (4) Capital
Based on what you spent or the estimates of the βworth of valueβ of the item or outcome. For example $25k to build a prototype, assign a value of $100k on getting early adopter customers (which is a perceived value that fits in the Market category.
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Example
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Risk mitigation valuation step by step
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Key points
one of the easy valuation methods to defend
Need to ensure the value you put on it is related to the value from the investor point of view
Related to r&d, is the innovation revolutionary or merely evolutionary? Is there a significant barrier to entry? Is there a market for the innovation? What the r&d spent on solving a specific problem / market need?
The VC quick valuation method
This is based on how the VCs will answer the valuation question for themselves
Step by step:
How much money do you need in the next 18 months. For example $3M
Understand how much equity the VCs want. Itβs usually around 20% which is the balance between being worthwhile and not too much dilution for founders and existing shareholders
Calculate the post-money valuation. $3M divided by 20% = $15M
Calculate the resulting pre-money valuation. $15M - $3M = $12M
Thatβs it!
This method is best for startups with:
Developed product/service and paying customers. Already moved past the early stages of product development and customer discovery
Quality metrics. You know the numbers in the business. Cost to acquire a new customer, customer churn rate, lifetime value of a typical customer
Stable operation and complete team. Full leadership team, great people in the team, operations well defined
Funding needs are well understood. You now fairly accurately how much money you need.
This method is not suitable for early stage startups. However as a well round founder keep the VC Quick method in mind as you work to raise the funding you need.
The VC valuation method
Relies on a few financial assumptions and ignores founder experience, customer traction, milestones. This method comes from the expectation of large returns on the cash invested in the VC portfolio. They use this expectation to derive the pre-money valuation for the startup.
Used for angels or VCs
Key points:
Starts at the exit target and works backwards to determine what it must be worth now.
Using financial projections. Annual revenue in the year of the exit of the startup. Also P/E multiples of public companies. Not for early stage startups. Need at least a few years of full operation and making profit
Incorporate ROI expectations. For example 20 times the investment. If the VCs canβt see the startup able to achieve their expected multiple they wonβt invest.
Step by Step
Exit value (in 5-7 yrs) / Current post-money valuation = Investor Desired ROI Multiple. Flip to be Exit value (in 5-7 yrs) / Investor Desired ROI Multiple = Current Post-Money Valuation
Estimate your exit value. 2 common ways to guess the exit value.
Simple. Find out the annual revenue multiple that startups in your space typically get acquired for. For example if it is 2X and your expected sales in the year of your exit is $20M then you exit value is $40M.
More complex using Price / Earnings multiples. For example companies in your space have P/E ratios of 10, your estimated before tax earnings is 16% (Return on Sales, ROS) your estimated revenue in year 5 will be $25M. 16% x $25M = $4M earnings. 10 x $4M = $40M exit value.
Calculate the post money valuation. If your exit valuation is $40M and the investors are looking for a 20X return on their investment then $40M / 20 = $2M post-money valuation.
Calculate the pre money valuation. If your target post-money valuation is $2M and you are looking for $500k from investors then your pre-money valuation is $1.5M.
Calculate the equity percentage owned by the investors. $500k / $2M = 25%
Considerations
One Big Assumption. The investors will need to believe in your exit valuation. Use this method together with other methods
Understanding the VC mindset. A good thing about this method is it gets you aligned with what the VCs want. Exit for $X in Y years with a Z times return on investment.
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