What are the Factors That Really Impact Your Startup Valuation?
Startup valuation could end up being a deal breaker. Startup valuation is not only impacted by its development stage, but by several other factors as well.
From seed to M&A to IPO, startups need to raise money at different stages of development. It’s a question of survival. One of the main issues they face during that process is ‘What is your company’s pre-money value?’, or in other words, ‘What equity percentage of your company do you offer in exchange for investors’ cash?’
With these questions, startup valuation becomes the equivalent to a search for the Holy Grail. Most of the time founders simply guess about valuation, based on rumors of the high valuation of comparable startups. With little knowledge about valuation, they provide investors with absurdly high figures, often at a stage where there is still no revenue! As a result, they risk killing the deal.
Let’s review some tips together to help avoid these types of situations.
There are four key factors when it comes to determining startup valuations:
- Team and Technology
- Market Size and Forecasted Revenue
- Simultaneous Term Sheets
Team and Technology
Is your technology disruptive? Does it bring a true breakthrough in comparison to the actual practice and “know-how” in your market? Who is your development team and who is your CTO?
Investors invest in a team first. They need to be convinced that R&D team members – especially those responsible for development – are talented and capable of achieving the necessary technical goals. Investors also want to see that team members are directly interested in a company’s success through different equity packages, including stock options or company shares.
One of the main issues for potential investors is when startups outsource their technological development for financial considerations. We have seen startups lose ownership of their algorithms, and face high risk of being copied by potential competitors. When this happens, it’s a deal breaker for investors.
In addition, investors want to get a common sense feel of how much time and money it would take for any potential competitor to copy your technology. The higher the technological barriers are, the higher the value of your technological asset will be, and therefore the higher your startup valuation.
Market Size and Forecasted Revenue
Investors, especially venture capital firms, buy a founders’ vision, including high risks. They look for big numbers in market size, and forecasted revenue and high return on investment, as well as an exit event in a short period of time (2-5 years). If investors feel that the company’s market size is not at least a few billion dollars in market size, it will prevent any future possibility of raising capital.
Many times, founders provide an exaggerated valuation of their company in order to avoid future dilution. This will kill a deal. When approaching an investor, you should have a business plan that includes a 2-3 year forecast with reasonable revenue, based on realistic assumptions designed to derive a fair valuation. Using a benchmark valuation tool – based on multiples of comparable companies and deriving your startup valuation – is highly recommended as a basis for future negotiations with a potential investor.
To find out your company’s true value, you can use AlgoValue’s Enterprise Valuator to calculate your business valuation online in minutes
Below is a snapshot of AlgoValue’s Enterprise Valuator:
Simultaneous Term Sheets
The margin of negotiation regarding your startup valuation is directly linked to the number of investment proposals or term sheets that you have received at the same time. Assuming that the most important goal for your company is to raise money, two scenarios should be considered:
- You have received only one term sheet. In that case, your margin of negotiation almost doesn’t exist.
- You have received several term sheets at same time. You can provide a higher valuation to investors who have offered the lowest valuation.
When we look at recent market data of US-based companies, we can see that a median pre-money valuation of Series A rounds in 2015 and Q1 2016 (excluding Angels and non-US based companies) were approximately $12 million, representing a higher valuation than in Europe (approximately $3 million according to Angel List). This median pre-money valuation of Series A round has been increasing by 100% from 2011 until Q1 2016 (source: “The Entrepreneurs Report, 2015”, Wilson Sonsini Goodrich & Rosati):
As a result, startup valuations have been decreasing within the last several months, especially in the U.S. Many investors, especially in the crowdfunding space, are not willing to pay the high price requested by startup founders and many capital raising processes were dropped and not pursued. This is why a valuation tool is recommended by so many crowdfunding platforms as a valuation tool to better negotiate a company’s pre-money valuation.
- Providing an exaggerated valuation of your company can be a deal killer.
- Take a top-down approach when estimating your company’s value – from market size to forecasted revenue.
Using a solid methodology to valuate startups is often a stronger basis for future negotiations of a fair pre-money value.