Valuation · Entrepreneurship

How do you approach valuation pre and post revenue?

Mikko Koppanen Senior Technologist

September 23rd, 2015

As a quick background intro: we are a mobile marketplace where parents and parents-to-be can buy, sell and swap their nearly new kids items and clothing with some new items from various brands mixed in. Hence, we are not making profit from app sales but rather from transactions happening inside the app.

We are currently in the process of launching a private beta with real peer to peer payments (scary stuff) and we have talked to some potential investors. The question about valuation came up recently and while we have given this some thought I feel that it's about as exact science as astrology. Here is a rough list of bullet points on how I've approached the valuation this far:
  • Profit and projected profit (doesn't really apply yet, a big guess)
  • Amount of R&D invested into the product
  • Potential market size, expected growth in the market
  • Cost of customer acquisition
  • Previous experience of the founders and how it can be applied to the market
  • Compare to similar companies and look at their earlier valuations (seed, angel, series A etc)

While every entrepreneur should have a healthy ego and trust to their product I don't want to give inflated figures just because I feel that the product and the team is great. So I guess to summarise my question: How do you approach to valuing start ups? What are the factors you consider and is there something in my list that looks like it's not worth the focus? 

I understand that the question is a bit broad because valuations vary wildly based on industry, individual perception, phase of the moon etc but I am after some generic points to take into consideration.

Benjamin Olding Former Co-founder, Board Member at Jana

September 23rd, 2015

Couple tips:

1) All "valuations" are not created equal.  Someone offers me 3x liquidation preferences, the answer is no at any valuation...

2) You don't set valuation, your investors do.  If they are asking for guidance, give a big range.  Or flip it around and ask them what it should be with a sincere, straight face.  Ultimately you want 2 investors bidding on the same shares, and then you want to guide them to the deal you want (where valuation is just a small part of that - liquidation preferences, anti-dilution clauses, pre-investment available ESOP pool, board seats, voting rights are all part of the deal too).

3) "Pre-money" valuation is a myth and a trap.  There is no such thing.  Valuations are strictly post-money.  Your team plus a $1?  Not worth much (sorry - no offense).  Your team plus $5M?  Worth hopefully a lot more than $5M more, because you can put that money to use.  So don't be thinking about the past - valuations are based on the future.  Your team isn't inherently "worth" anything - but your team plus a market opportunity plus money in the bank to execute?  Well, that's hopefully worth quite a bit.  Until you have a liquidity mechanism, pre-money valuation amounts are dumb to even calculate - entrepreneurs who think they reflect the value of what they have built are generally clueless.

4) At the stage you are at, spreadsheets are a distraction.  Kind of sounds like you're a spreadsheet guy with your bullet point list of different ways to calculate a valuation.  Do you have someone on the team who excels at sales?  Selling your shares is a sales exercise - let them lead more.

5) The investors you are speaking with have an ownership plan.  Early stage investors want to own 20-30% of your company (maybe more).  Later stage might be interested in as low as 10%.  They will negotiate hard for this amount and often be willing to pay a lot more.  Entrepreneurs instead often think in terms of wanting to raise a certain amount of money and then sell as few shares as possible (higher valuation).  There is (useless) tension in these two different views - embrace your investor's viewpoint (figure it out from past investments), then try to get more cash out of them for the same percentage equity.  While this drives up your valuation (making any anti-dilution clauses you agree to riskier), it also drives up the cash you have in the bank (lowering execution risk).

6) Whether it's in your nature or not, you need to be ruthless when negotiating.  This doesn't mean aggressive in demeanor (be yourself) - it means you need to create demand for selling twice the shares you will sell, and then play investors off each other.  

You raise money at most once a year and by yourself; investors go through this process often once a month and with a team.  You can't out-negotiate them - your only hope is to have them out-negotiate each other.  If you think you're going to come to terms with a professional investor based strictly on the "theory" of the value of your company, you are about to be taken to the cleaners.  You're sitting down to play poker with pros and you (and I) are mere amateurs - the only true solution is to make them play each other.  Say whatever you need to (including your opinion of valuation) to get 2 investors seriously interested, then let the bidding begin.  Just because you say a number to get them to engage doesn't mean you're going to end up with that number.

Peter Baltaxe Consultant, product leader, serial entrepreneur

September 24th, 2015

As an angel investor, my perspective is that there are a lot of factors that impact valuation. You've hit on a lot of them.  The financial projections for a company pre-revenue are really just an exercise in thinking through assumptions and convincing yourself that the business can make money on a unit basis, profitability will increase with scale, and that you don't need a double digit percent of the market to be a big business.  If those three things aren't true, then you should rethink the business, so in my mind the pro forma P&L does not contribute to valuation, it's table stakes. 

Having a revenue is really important, because it is a key milestone in customer traction and means that someone is willing to pay for your product/service.  However, amount of revenue and rate of acceleration of that revenue is important as well.  I've invested in a couple of SaaS businesses that had promising early customers and revenue, but the rate of growth has been disappointing, and so it is harder to get a big pop in valuation when they go for the next round. Some of the below are directly related to revenue, and some are not.  Important factors in valuation for me (not in any particular order) are:

  • Does this team or at least the CEO have a track record of entrepreneurial success?
  • Does the team have domain expertise?
  • Is the team complete (i.e. contains all key functional leaders needed to execute, CEO, head of tech development, marketing/sales/bus dev, etc).
  • How many engineers are on the team (this is a big bottleneck for many early stage companies. For example, if you already have 3 or more engineers who are full time or part time and waiting for fundraising to jump on board, then that really helps.)
Customer Traction
  • How many free or paying customers are there?  You can be in a pre-revenue state but with a good pipeline of customers trialing your product and saying nice things about you can still do well on this criteria.
  • How long is it taking to acquire customers? (Even trial customers)
  • If it is consumer, what is the growth rate looking like? Is there a 1+ viral coefficient or what is acquisition costing and is it scalable?  Is it a freemium model and do you have aggressive or conservative assumptions re converting to paid?
  • If you are in the concept stage (or pre launch stage and have no customer traction, then that hurts your valuation a lot.  If you have solved a hard technical problem and have a way to protect that it is a mitigating factor. (see below)
Product Traction
  • If you are not live yet, how robust and differentiated is your product? If you are following lean you have some product out there that is generating customer involvement and proving that you are on the right track.

What intellectual property have you developed?
  • If you don't have customers yet, at least hopefully you have solved some hard technical problem. Ideally one that is protectable. What stage are you with patent filings if relevant?
  • If you have written a lot of code, it doesn't necessarily have a lot of value until you have proven that it solves a problem for a lot of customers.
Business Development
  • What key relationships have you locked down either for distribution or sourcing?  This is a sign that you can sell and it de-risks execution.
  • How hard is it to get those deals?  Are they exclusive?  Are they direct or through intermediaries?

  • How big is the market?
  • How differentiated is your approach, and how crowded is the competition?
  • Are you early or the third or fourth startup in the space?

If you rank poorly on all the above, you will struggle to raise money at valuations above $2MM. Investors realize that companies need to raise $250K - $500K to get going and they know entrepreneurs can't give away half the company to get the seed in, so there is just this basic math at work as well. That said, accelerators are getting equity in startups at <$1MM valuations because those companies need help developing the above proof points that de-risk the business.

Benjamin made a comment about "pre-money valuation."  That is different from "pre-revenue."  To clarify how pre and post money works:
If you decide to do a priced round for your seed stage (which I don't recommend, better to do a convertible note), you the entrepreneur can decide the asking price, e.g. $2MM in the current pre-funded state. You may have to lower that to get investment. But if you achieve a $2MM pre money valuation say, and you raise $500K, then the post money valuation is simply $2.5MM, and you have sold 20% of the company to get the first money in.  Your goal is to then execute like hell so that the company is worth $5MM or more the next time you need money.

My recommendation is to bootstrap until you have revenue if you can, and you will get a better valuation and spend less time fundraising, because it's not just a good idea, you now have paying customers!   

Regarding your particular idea, check out OfferUp. Based here in the Seattle area and getting a lot of customer traction now.

Mark Talaba Founder, Vision Former, serial entrepreneur

September 25th, 2015

You have two well-founded  and valuable responses -- pay particular attention to Peter's closing comments, I'll just add thoughts from the 'serial entrepreneur' side. 
-- Passion and positive team chemistry mean a lot. May not count for much with prospective investors, but can keep your company going even in dark times. 
-- Friends and family investing need not be limited to startup -- not if you can show ongoing business advances. 
-- Just as 'financial' buyers of businesses have objectives (and valuation specs) that are very different from 'strategic' buyers, there are investors at every level (f&f to VC/PE) who will look at your business with greater or lesser enthusiasm. Your 'strategic' backers will share your passion for what your company does, and/or will see a tie-in to their own business interests. That's where better you will have a much greater opportunity to make the case for higher valuation. 


Mikko Koppanen Senior Technologist

September 28th, 2015

Thank you everyone for detailed and very informative answers. Certainly a lot of new things to think about. I come from a tech background rather than business so Benjamin calling me "clueless" might be somewhat accurate, although I disagree that a working pre-revenue product is worthless. 

Mark: We are currently bootstrapping with our own funds and I agree that we should postpone things until we start making revenue. We are currently passing the last hurdles with payments, legal and tax so hopefully that is very soon :)

Daniel Faloppa Founder @ Equidam

January 18th, 2016

At Equidam we use a combination of DCF adjusted for startups (which have a high default rate) and modified asset methods that put a heavy weight on team and traction, you can try it out at!