When it comes to raising money for your startup, the two biggest questions on every entrepreneur’s mind is “how much is my company worth?” and “how much equity am I ready to give to investors?” If you are a real boss, you’ll know exactly how much your company is worth without VCs complaining it’s valued too high, but you’ll also know how much to give away without selling yourself and your company short.
First, let’s start with the three typical ways to calculate your company’s value.
1. Asset Valuation
This approach is where you put a dollar price on all assets on your company’s balance sheet and add them all up for a grand total. What counts as an asset you ask? There are two types of assets- tangible, or anything that can be turned into cash quickly, and intangible, anything non-physical but adds value and reputation to your company.
- Tangible assets include: machinery, office furniture, computers, inventory, prototypes (plus the cost of developing them).
- Intangible assets include: trademarks, incorporation papers, patents (which can realistically add $1 million to your company’s valuation), principals and employees like programmers, engineers, and designers (who can also add $1 million each), sweat equity of the founders and executives who didn’t take their theoretical salaries, client relationships and accounts, and goodwill (in the simplest terms, the reputation of your company’s brand in the market).
tl;dr: Add up EVERYTHING (and everyone) your company owns. Voila!
2. Income Valuation
Income valuation covers the value of your company by how much money it can/will make by projecting your company’s profitability. One way to do this is to calculate your company’s EBITDA, which is your net income (earnings) before interest, taxes, depreciation, and amortization (business expenses). Everything you need to calculate EBITDA can be found on your company’s income and cash flow statement. It’s a fairly simple process, but while you should definitely have those figures in your pitch portfolio, it’s not considered the most accurate measure of your company’s value.
tl;dr: Earnings Before Interest and Taxes + Depreciation + Amortization = Your Company’s Potential Value
3. Market Approach
Where your company stands in the market also adds to its value. It’s the same as someone being born with certain advantages or disadvantages- in business, these traits are generally known as goodwill, the value of intangible assets, and can bump up your company’s valuation by millions.
- Goodwill includes: location (are you close to consumers and money?), contracts with customers (having big names under your belt makes you worth more), market share (investors like to see the target market for small startups to be around $500 million in potential sales, larger companies need at least $1 billion), and competition (your company is worth more if the competition is light).
tl;dr: Basically, the more popular your company is, the more valuable it may be.
When in doubt, you can also see how other companies did it. A simple Google search can tell you what comparable companies are worth, how much they were bought for, and other details to the kinds of deals that you might be looking for.
A VC’s Point of View
On the other hand however, most experienced VCs and Angel investors will probably tell you that there really isn’t a “right” way to get your answer. Tim Chang, the Managing Director at the VC firm Mayfield Fund, shared some valuable points every entrepreneur should know when it comes to raising funds.
Tim explained that, “[There’s] Definitely no precise mathematical or formulaic answer. The real answer is whatever you can sell potential investors on!” According to Tim, there are four key factors that make up the value of your company:
- caliber and credibility of the team
- traction to date
- target ownership percent of the investor
- the amount you’re looking to raise to reach the next milestone and next round of funding
Rookie founders can also make a number of mistakes when looking for investment funds. Tim explained the four biggest mistakes founders make when making deals with VCs:
1. Over-optimizing for the current round and raising too little at high valuation.
According to Tim, this is the best way to hit a downround or “crunch” in your next round. “Sure, you can convince some dumb angel to give you $500,000 in a $20 million capped note, but when you (quickly) run out of your seed note and go pitching for a Series A with anything less than explosive organic traction, I’m going to look at your cap, laugh, and walk away. You’ll get the same reaction all up and down Sand Hill Road, and then realize that you’ll be pitching a second seed at greatly reduced valuation.”
2. Raising too much at too high a valuation.
While more money is always good, Tim explained why getting too much too early is bad for your startup. “Remember that your valuation you raise at is the hurdle you pick for yourself to jump over at least two to three times higher for your next round. Choose wisely, and think two steps (and two rounds) ahead.”
3. Optimizing on dilution only.
“Most entrepreneurs only focus on minimal dilution, sacrificing caliber of investor and gas in the tank in exchange. That’s fine, but your execution and product market-fit better be flawless for raising the next round!” If you raise money with your focus on giving away the least possible equity, you better have a killer product to back it up or you might not raise enough to even get to the next round- don’t get greedy now.
4. Know the normal amount of equity to give away.
Tim explains that “top tier VCs want 20-30% ownership for early stage deals.” If you are raising funds from super-angels, look at letting go of 10%. “Wannabe angels with fake micro-funds may invest whatever just to be part of the action. Each type of investor also has a minimum and maximum check size they can write.”
Each case is ultimately different though, as Tim explained, “For really capital intensive plays needing a lot of money before a product can be built, expect to give up 40-50% dilution between one to two VCs, unless you have a killer track record of prior hits. Otherwise, for seed and early stage deals that are more capital efficient, expect to give up 15-35% dilution depending upon the amount raised, buzz and traction.”