How do I set a realistic valuation?

QUESTION:

Whenever I pitch a VC, they ask about my company’s valuation.  How do I set a realistic valuation?   How do I even know what my startup is worth?

ANSWER:

You don’t know.  No one knows what it’s worth.  In fact, it’s only worth what someone will pay for it.  That’s the catch 22.  You can pick any number you like, but you’ll find that certain numbers are more realistic than others.

First off, there are several factors that influence how valuations are set.  Below are some of the main factors:

1)  Competition amongst VCs — the more investors who want in on the deal, the higher the valuation

2)  The team — strong teams tend to command a higher valuation

3)  Growth — rapidly growing companies with traction are valued higher

4)  Opportunity — if this is a big opportunity, meaning a potentially huge exit, the valuations tend to be higher

5)  Revenue — most startups don’t have much revenue, but if you do, this can influence valuation

6)  What you’ve invested in the company so far will affect how investors perceive your company

7)  Any previous valuations by outside investors will factor in

8)  What other investors are participating in the deal

9)  How much capital you need to execute on your business plan

10)  Any unique IP or technology advantages your company has

There are even more factors, like who’s on your board, that come into play.   That said, you can ignore almost everything above and focus on one factor:  competition amongst VCs.   This is truly the main driver that affects most startups’ valuations.  If you can create a competitive environment and get VCs bidding up your company, you’ll get a higher valuation.

So what should you say when an investor asks what you think your company is worth?   I suggest you respond, “The market will determine our valuation” and leave it at that.

You can also look at similar companies in the space who are at the same stage and see what valuations they are getting in the marketplace.  In most cases, you won’t get a better than average deal, so picking the average is probably fine.  If you don’t know what the typical valuations are for your company at your stage, start networking and asking VCs, CFOs and other people plugged into the venture and angel community.  They can help you get a realistic grasp on this.

Lastly, don’t obsess over valuation.  It doesn’t matter as much as you think.  What’s more important than valuation is speed to market.  The high tech space is moving at light speed, and if you hold out for the best deal, you may just miss the opportunity altogether.   So grab the money you can get at a reasonable valuation and run with it to build your business.   In the end, your success or failure won’t be predicated on your valuation.   It will be determined by a million other things — including whether or not you get your business off the ground quickly.

Comments & Advice:
  1. It is important to note that the strategy of “we don't our valuation” only works until you MUST know your value. If you intend to use compensation devices that may fall under IRC 409A you need to have a valuation established that is both reasonable and provided by someone who is trained in valuation.

    Your 409A value does not have the be your “investor value”. It does not even need to be your potential value. It is a value that is determined using generally accepted processes and use specifically for the purposes of this section of the tax code.

    Here's a link some good information on this topic from my friends at TwoStep Software: http://blog.twostep.com/?Tag=Section%20409A%20requirements

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