TRC 009: How to set a valuation for your startupMay 18, 2023
Read time: 5 mins
When approaching investors to raise funding, knowing how much to ask for and at what valuation can be tricky.
Despite all of the different financial models available to help, when a business is just starting, it’s as much an art as it is a science.
The easier bit is working out how much you might need to achieve a specific goal, such as getting a product to market, moving from MVP to revenue generation or hitting a particular revenue goal.
At the early stage, this is most typically a factor of the people needed to achieve the goals, with a few extra costs that keep the business running - such as overhead costs and marketing or sales expenses.
It can be more difficult, as a first time founder, to know how to value your business.
A broad rule of thumb is that any funds you raise at an early stage will dilute your shareholding by an average of 20%.
As an example, if you are raising a first round of $250k in funding at a pre-money valuation of $1m (and therefore a post money valuation of $1.25m), the new investors will own 20% of the company.
The 20% dilution average can be affected by several key factors - meaning more or less dilution for the founder/s - typically in the range of 15-30%.
Here are the main things that investors will look at:
- Management team: Is this your first rodeo or have you and the team been there and done it all before?
- Stage of product development: Have you only got an idea and a set of wireframes, or is the product built and ready to go?
- Strength of the business model: Are you really clear about how you will make money and have already validated this with potential customers, or do you just have a broad theory about what you will charge?
- Quality of execution: Investors will look at what you have already achieved (no matter how early), the quality of your thought processes and your attention to detail.
- User traction: The killer app. If you are already growing like crazy at a low and sustainable cost of acquisition, then it’s much easier to reduce the amount of dilution when raising money. It also really helps if you can prove that they are likely to stick around.
- Comparables: What similar funding rounds can you point to for businesses at a similar stage and an in a similar industry? No investor wants to overpay vs the market so they will always look to benchmark.
Depending on how you think you measure up against each of these, you can factor in more or less dilution when raising your round.
It is important not to maximise valuation to the extent that the growth expectations over time become unmanageable, or that you have to take bad investment terms as a result (such as a greater than 1x liquidation preference).
It is better to have a clear understanding of what you need to raise to achieve your next key milestone and base your valuation on market averages for where you are and what you have achieved to date.
You can always make it more complex, but, like most things, keeping it simple tends to pay off in the end.
If you need more help with this, our Ultimate Pitch Deck Course contains more guidance and step-by-step tools, such as The Ask Validator, that will help you refine your ask to investors.
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