Don’t roll the dice for your startup valuation

They say startup valuation can be as much an art, as a science.

And they’re right. Because ultimately, it’s a negotiation between you and the person you’re convincing to invest in your business. And we all know negotiation is an art.

As specialists in the startup space, we’re different from regular accountants, and we can give you a valuation base to confidently negotiate from.

We do this through formal startup valuations that take into account a whole heap of things. If you’re interested in this by all means, get in touch so we can explain what that means.

But if you’re an early stage startup, you might just want a general idea about what sort of ballpark you’re operating in. Here, we’ll show you two pretty quick ways to understand that.

But first…

What’s wrong with a startup valuation being too high?

There are two main problems with this:

If you’re pitching to an angel or venture capital investor, you could be berated at best and laughed out of the room at worst
If you’re doing a friends and family round and overvalue your company, it will make it hard for an angel or venture capital investor to come in at a fair value (in their eyes) down the track. And if you do go through with a lower value deal (called a downround), this can lead to some difficult conversations with your earlier family and friend investors about revaluing their shareholding, downwards, in order to make it attractive for these investors

Tech startup valuation

In Australia, there’s a quick way to come up with a first-round, lower level, tech startup valuation.

It’s based on one of Australia’s main tech accelerators, Startmate, which offers $75,000 in exchange for a 7.5% stake in an early stage tech startup. It does this for a huge variety of early stage startups.

If you do the math ($75,000 / 0.075), this values a pre money tech startup at $1 million.

Obviously, this is a very simplified way of determining a pre-money valuation for a tech startup. But it does provide a local benchmark, of sorts.

It also ties into the typical pre-money startup valuation for angel investors in Australia, which is between $1 million and $3 million. This means a pre-money valuation for a friends and family round before an angel comes in is usually between $250,000 and $1 million, although you can sometimes see some pretty strange valuations between new startup founders and their family and friends.

And, as Alan Jones from M8 Ventures, reminded us on Twitter recently, this assumes that your tech startup is good enough to be accepted into the Startmate accelerator.

How can you tell? He suggests looking at the startups they have chosen so far and understanding what stage they are at. For example, do they have a minimum viable product or a 1.0 product? Do they have a partial team or full team? What is their experience? Do they have any customers?

Work backwards from how much you need

This startup valuation method involves figuring out how much money you need to achieve your plans, and then working backwards from there based on the 10-30% “rule”.

What’s that? It recognises that, on average, every time you raise funds from investors, you typically give up between 10% and 30% of your equity. Yep, every time.

So let’s say you’ve put together a plan and a financial model that shows you need to raise $500,000 for your early stage tech startup.

Here’s how that translates into a valuation, based on how much equity the investor will get in exchange for their $500,000:

At 10% equity you are valuing your company at $5 million
At 20% equity you’re valuing your company at $2.5 million
30% equity gives you a valuation of approximately $1.7 million

How do you determine which percentage of equity you’ll ask for? It might be tempting to offer the lowest amount of equity listed above (10%), but is your startup really worth $5 million (as in our example)? Can you confidently support this when negotiating with an experienced investor?

This method puts you in the zone to not be dismissed out of hand, and gives you an operating range to start negotiations from. The value that you settle on will reflect a range of factors, including your product, how good it is, how experienced you and your team are and where you’re up to in terms of development and sales.

It’s just a number

It’s worth remembering that your startup valuation is just a figure. It doesn’t mean anything unless you are successful in raising funds.

And even then, raising funds is not the real story despite the headlines and articles we regularly see about it. It’s what you do with the funding to increase your company’s value and ultimately achieve a successful exit that will see you sipping cocktails on the beach in your slippers, living the startup dream. Go well!

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If you need a professional startup valuation, we can help. Find out how it works here.

Pic at top by Fabian Reitmeier on pexels.com