“What is your valuation?”
As an angel investor, this is one of my first questions when talking to founders for a potential investment. And often, I hear numbers that are either too low or very high.
For instance, a founder who had graduated from an elite business school recently told me his early-stage fintech firm was worth $50 million. The startup had two employees who were both in business school full time. There was no IP, no MVP and the founder had only a general idea of the go-to-market strategy. I ended the meeting soon afterward, because the factors they used to arrive at the valuation had no basis in reality.
Another CEO I spoke with had a game-changing product, sizable total available market (TAM), successful betas, some product sales, an impressive team and a well thought out go-to-market strategy. When this founder said the business was worth $500,000, I advised her to reconsider her valuation of it because it was extremely low.
Many investors would not offer this kind of advice to a founder they had just met, but because the startup had potential, I encouraged the founder to redo her homework.
What is “valuation”?
A startup’s valuation denotes what it is worth at a given point in time. Factors that make up the valuation include the development stage of the product or service; proof-of-concept in its market; the CEO and their team of her; valuations of peers or similar startups; existing strategic relationships and customers; and go out.
While there is no exact science for figuring out how much money you’ll need down the road, certain sectors and industries have patterns you can look for.
Entrepreneurs typically value their startup when raising capital, or while giving shares to their team, board members and advisers. Having an accurate valuation of your startup is critical, because if you overvalue it, investors likely won’t give you any money.
On the other hand, undervaluing your startup means you’re giving up a lot of equity for less money, or you’re undervaluing what you have built so far.
It’s more art than science
There isn’t a straightforward formula to follow when valuing your startup. Because most startups can’t really prove their commercial success at a large scale, valuations take into account the nature of the product or service, projections for the business and the TAM.
You may have heard that valuation is more of an art than a science, and it’s often true — startups often don’t have enough concrete data at the early stage and face a range of risk factors that could change the course of the business. Many traditional valuation methods, such as discounted cash flow, aren’t as useful for valuing early-stage startups. This means investors have to gauge other factors that aren’t so easily measured.
As a founder, your job is to showcase: