Fundraising · Valuation

How much equity should we give our 1st investor?

Frank A CoFounder, UI/UX designer

Last updated on July 10th, 2019

We are 'early stage', not even coded yet, but lucky enough to have our first investor! How do we figure out a valuation that makes sense for us AND the investor?

David M

July 10th, 2019

Frank, Has your investor not yet actually invested in your company? If they have, I am assuming you either have a friend or family member investing, or an inexperienced investor. There is no one right way to do this, though plenty of wrong ways. A lot of elements go into valuation including revenue, IP value, growth projections. One perspective can show your company has great value currently pre-revenue. Another perspective can say your company is worth absolutely nothing because you have no revenue. Bottom line is you own the company. You have an idea of where you want to take the company and how much you think that will be worth. And only you and the investor can figure out what you are both comfortable with. Contracting a huge amount too early could discourage future investors. Not contracting enough might discourage your current investors. There are positives and drawbacks to every type of valuation I have seen. Most people pitch their method as tried and true but none are and I have yet to review any type of "100% accurate" valuation method from anyone that I can not break apart based on varying perspectives and logics. Again, if your investor is used to using a certain approach to valuation, that may be what you have to go with, though always negotiate.


What you can do currently though is evaluate the people involved or that will be involved. The last thing you want to do is contract a piece of your company for a relatively small amount of investment capital now..for equity that could be worth a whole lot later if the people you are working with are not going to put in their fair share of time and work. Generally this is where your traditional vesting comes into play.


You need to have an anti-dilution clause. Can't tell you how many entrepreneurs and experienced businessmen alike who posture how much they know and do not have this clause in their contract...setting them up to devalue their equity exponentially down the line. You need one as a founder and if your investor is competent, he will require one.


Find the balance. You don't want to get caught up in picking apart every future potential of your company that will effect your equity value, but at the same time you don't want to just say "Hey we are starting a company...there are 4 of us lets split it equally."

Sujith Kattathara Bhaskaran IT Program/ Project Management Consultant, Startup Founder, Fledgling entrepreneur, Systems Thinker

July 10th, 2019

Hi Frank,

First of all - A big congratulations to you!


Let me clarify this first: I am not an Investor, Accountant, or expert in Valuation. I am simply someone who's learning the ropes.


If you are at the beginning of the Product development stage, and an Investor has expressed interest, then in my opinion he's not just an investor - He's (almost) a Co-founder.

Also, if he's bringing in any other contribution, such as Business networks or other complementary skills, then he's definitely a Co-founder.


Bottomline: Equity distribution at this stage, in my opinion, is not really based on a formal Valuation, but on a negotiated agreement based on relative contributions by the various Co-founders.


I would definitely welcome other thoughts on this topic, specially from folks who have "been there, done that".

Dane Madsen Organizational and Operational Strategy Consultant

July 10th, 2019

Most startups struggle with this issue. Valuation and value are inherently not connected, but that disconnect is not well understood. Y Combinator (arguably the most experienced in this stage) created the SAFE for this purpose. It avoids the valuation discussion until a better picture of value can be established.

Frank A CoFounder, UI/UX designer

July 10th, 2019

Thank you for your input, Sujith...much appreciated. I, too, look forward to additional responses.

Jemar Souza Building coworking spaces for music artists

July 11th, 2019

Hi Frank,


Like Sujith, I'm also someone learning the ropes, happy to share what I've discovered so far.


Based on what you've shared with us, I wouldn't recommend giving any equity until you have a professional valuation done for your company. Instead, in the mean time, you should look into and negotiate a convertible note.


via Seed Invest

The primary advantage of issuing convertible notes is that it does not force the issuer and investors to determine the value of the company when there really might not be much to base a valuation on – in some cases the company may just be an idea. That valuation will usually be determined during the Series A financing, when there are more data points off which to base a valuation.


Hope this helps!


Jemar

Paul Garcia marketing exec & business coach

July 11th, 2019

It's never a good idea to give equity, rather equity should be an exchange for value. Sometimes that value is cash, sometimes it is expertise. But an equity investment is not the only way a source of money might agree to invest. They may interested in a loan, a convertible note, common equity, preferred equity, convertible equity, or exchangeable shares. It really depends on what they think will happen and how much control they want.


Valuation, well that's the big mystery. It's an educated guess and there are many different models. Typically there is a model common to your specific industry, however all models require you to back up assumptions with facts. When you're pre-revenue, it's all a risky guess, so both you and your investor have to make a fair determination.


The thing to remember is that whatever deal your first investor gets is (typically) the deal for all the other following investors, so you only get one chance to set your value or model for investing.