What's the Valuation of my Early Stage Startup?
Unfortunately, the answer is not that simple.
Early stage startups have very little hard data to rely on in the calculation of their valuation. This makes it impossible to establish an indisputable valuation. You’re not the mature, publicly traded company with enough information and data to provide investors with financial models, market analysis, and clear valuation calculations. So how do you come up with your valuation?
First, look to the data and information you have.
Take an inventory of everything that gives you confidence in pitching your business.
Team: Do you have any industry experts, reputable advisors, well known investors, serial entrepreneurs (that have exited) on the team?
Product: Have you built anything yet? Working mock-ups, prototypes, or working products?
Customer: What kind of validation do you have from the market? Do you have commitment letters from customers to use your product, trial use agreements, emails showing a big prospective customer’s interest in what you’re building, or anything else that shows you that what you’re building would be in demand?
War Chest: Do you have any patents, high-value domains, registered trademarks, or significant trade secrets?
Market Size and Trends: How big is the market you’re going after? Is your industry trending and hot right now?
Strategic Partnerships: Do you have any strategic, high-value relationships that would be difficult for another entrant in the marketplace to get (ex: commitment for manufacturing, retail distribution, white-label/licensing, exclusivity of some kind)? Can you show that relationship with a letter of intent or memorandum of understanding?
Comparables: Are there competitors or other reasonably comparative businesses in the market that have data available that you can cross reference for support of where you’re at or what you’re going after (ex: valuation, growth rate, acquisition price)?
Each one of these things contribute to the formation of your valuation, and the more of them you can identify and support, the more substantiated and substantial your self-determined valuation becomes.
Second, think about your financing roadmap.
There is strategy involved in setting your valuation.
You need to think about how the valuation you’re setting today will affect your next financing, and even the financing after that.
It is important that you’re able to show increased value from financing-to-financing, taking into account the additional capital you raise at each of those stages. If you reach your next financing, and cannot substantiate a significant growth in value from the last, you will have a harder time raising capital. And if you do still get interest, the financing terms will likely be much more penalizing due to the perceived risk of little to no growth. This is where cap table math and modeling becomes important for data based decision-making.
Third, test your assumptions with trusted advisors.
Once you’ve run through the exercises of the first two steps, take your self-determined working valuation, and the assumptions you’ve based it on, to your trusted advisors for their experienced feedback.
Bite your frustration at this step. Often times, one advisor will tell you that you’ve grossly undervalued yourself, with the next saying that you’ve grossly overvalued yourself. This is simply a reflection of the fact that it is impossible to establish an indisputable valuation at your stage.
Take note of their feedback regardless.
What kind of weight do they put on each of the items you’re relying on to substantiate your valuation? What is their strategic reasoning for their opinions? What are they drawing from to support their opinion? Putting aside their conclusions, this is meaningful information to help refine your position.
Finally, make a decision.
After all this, you just have to make a decision. It will never feel perfect.
Remember, your valuation is ultimately whatever an investor is willing to invest at. So your confidence and ability to sell it is arguably the most important component to the valuation exercise.
If you can convince investors to invest $1M at a $10M valuation… guess what, you’re worth $10M. If you can’t convince them to do that, and they are only willing to invest their $1M at a $5M valuation, well…. now you’re worth $5M.
Of course, it also matters who you are pitching to. Some geographies, investor groups, and markets have a greater appetite than others for high valuations. Know who you’re pitching.
To sum it up…
With all these variables, and with little to no financial data to rely on, the key to setting a valuation for your early stage startup is: (a) to inventory all that you have that gives you confidence in your pursuit of this business at this time, (b) know your financing roadmap and how your self-determined valuation fits in strategically, (c) get input from experienced and trusted advisors, then (d) make a decision and go.
Ink LLP is a business law firm that acts as strategic counsel to ambitious entrepreneurs, investors, and high-growth companies. Contact one of our lawyers to discuss your business and how our team might be able to help you tackle the challenges of your business and the opportunities for growth.
This information is provided for informational purposes only and is not legal advice.