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How do you determine equity valuations for pre-seed funding?

My co-founder and I are launching into the development faze of a new online marketplace after about 8 months of research. We are hoping to raise a small amount of pre-seed capital (200K) and are trying to determine company valuation / equity. Any suggestions for helpful literature / resources?

9 Replies

Nick Imrie
1
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Nick Imrie Entrepreneur • Advisor
Experienced digital MD, Senior Marketing Executive & Board Advisor
Hi Ethan like this article on the subject: http://venturehacks.com/articles/seed-valuation As a private investor and startup CEO (i am both) i would also say why set a valuation at all at this stage? I.e. maybe look at a convertible which have upsides and downsides BUT In my experience setting for example to high a valuation now can make it super harder to raise money in the future unless traction numbers go through the roof and thus by Series A stage the company needs the dreaded "Unicorn" numbers ;-( to raise money again..... As a PI i have been relaxed at this very early stage not setting a fixed valuation.... Nick
Mike Moyer
2
0
Mike Moyer Entrepreneur • Advisor
Managing Director at Lake Shark Ventures, LLC
Slicing Pie is a book I wrote on this subject. It outlines a model for allocating equity in bootstrapped companies. It is the only model that will give you an exact, perfectly fair split for you and your team. Every other model is based on guesses, negotiation skills, rules of thumb and predictions about the future that are always wrong.

I'll send you a copy if you contact me through SlicingPie.comYou will love it.

Here is a quick infographic overview:

Alex Eckelberry
1
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Alex Eckelberry Advisor
CEO at Meros.io
IMHO, raising money at a set valuation at seed stage is a terrible idea. I would much prefer to raise a seed/angel round at a convert to the Series A, providing a discount (say, 10%-15%) to the conversion and adding in some interest.

But that is a harder sell, certainly.
John Seiffer
1
0
John Seiffer Advisor
Business Advisor to growing companies
Maybe you can avoid raising seed money from investors all together. If there's a serious demand for your product, especially with big companies, sometimes potential customers or even vendors will give you seed money to build it or launch in exchange for discounts or some benefit in the future. Even if not, having discussions like that will show how much they really care about your product, and that kind of evidence of traction will go a long way toward increasing your valuation if/when you do raise money from investors.
Aji Abraham
1
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Aji Abraham Advisor
Technology Expert for Startups
Setting a valuation is going to be hard at the idea level. One benchmark that you can use is the valuation done by major accelerators. Techstars take 6% equity at $300K valuation. In addition they give $100K in convertible debt. YC also value seed stage companies at $250-500K. Most companies in the accelerators are far along the product development than just ideas. As others have mentioned it would be beneficial if you can raise the investment a convertible note at this time. The helps you to push the valuation discussion to future where you have a product and some traction. Good luck.
Karl Schulmeisters
3
0
Karl Schulmeisters Entrepreneur
CTO ClearRoadmap

I think the key here is this comment

We are hoping to raise a small amount of pre-seed capital (200K) and are trying to determine company valuation / equity.

What I really am hearing being asked is

We want to give away the smallest block of equity to get $200k that we can. How do we value ourselves to do this

The reality is that because you don't have the dollars, this is really more of a value sell more than anything

  • What can you convince the investor your idea is worth in 3 years
  • What is the risk associated with you being able to deliver that value
  • what risk are you willing to take of not getting paid for 3 years of work

Here's why. Any seed investor that is going to put in $200k is going to expect a $2Million payout in 3 years. That means for you to retain any cash benefit, you have to be able to re-finance the company at $2million plus because regardless of whatever fraction of equity you give them, the contract will be written that

  1. they can force a sale - or to have their shares bought out at a pre-agreed valuation
  2. they get the first $2 million of any refinancing

So that means that in 3 years, you really want to be able to refinance for about $4 million ($2 million to buy out the Seed investor, $300k to pay yourselves a salary boost, $1.7 mil to grow the company to $40 million in another 3 years).

Work backwards from that

Scott McGregor
2
0
Scott McGregor Entrepreneur • Advisor
Advisor, co-founder, consultant and part time executive to Tech Start-ups. Based in Silicon Valley.
If you are pre-traction, be aware that there will be immense fuzziness in what your valuation is. At that stage, it is very much like buying and selling a house -- the sale price is NOT the asking price, nor is it the offered price -- the price is the one that's agreeable to both parties, and if no agreement is possible the price (valuation) remains unknown. Still you'll want a ball park figure, and again the comparison to the housing market is helpful. Every house is one of a kind, so there is no exact formula, but there are other SIMILAR houses in the same neighborhood. Typically people will estimate the value of a house by averaging the sales price per square footage of COMPARABLE houses in similar neighborhoods (so called "comps") that sold recently. You can do the same thing in valuing start-ups. Find public companies or M&A deals of companies in your market. Find out their price/sales (P/S) and price/earnings (P/E) ratios -or in M&A the acquisition price / last years sales and acquisition price / last years earnings). Average several such companies on both factors. We'll call that the COMPS multiple. Multiply the P/S and P/E comps multiples times your forecasted best and worst sales and earnings over each of the next 5 years. This should give you a range of expected valuations. The more uncertainty in your estimates, the more uncertainty in your valuations, particularly on the downside. An example might help: Let's say you calculate that comps average in your industry are 2X for the P/S, and 10X for the P/E. Let's assume your expected sales for the next 5 years are: $500K, $2.5M, $5M, $10M, $20M. Assume your expected earnings are -$1M, 0, $1M, $2M, $5M Therefore your expected valuations will be: $1M, $5M, $10M, $20M, $40M by P/S. By P/E they'll be about 0, 0, $10M, $20M, $50M. So, your first valuation is probably going to be around $1M. Maybe it will be as low as $500K if it is a tight buyer's market, maybe it will be $2M if it is a hot seller's market. But it probably isn't going be $10M to start, and it probably isn't $100K. Obviously, every business and industry is different, with different multiples, and market conditions vary, but hopefully, this gives you a clear way to THINK about your early stage valuation.
Daniel Austin
0
0
Daniel Austin Advisor
Founder and CEO at GRIN Technologies, Inc.
This is a standard question for startups, especially for thos presenting new ideas without a market or with no sales revenue. There are basically 3 methods: 1) valuation on assets - this might include incorporation papers, IPR if any, interest in labor or systems already built. 2) valuation on prospective income - based on expected future revenue, but it's more difficult to estimate. 3) Valuation based on your idea - this is essentially arbitrary and obviously somewhat risky. None of these methods work terribly well. Under and overestimating your worth can result in a serious strategic error! Some references: http://fundersandfounders.com/how-startup-valuation-works/ http://www.amazon.com/Founders-Pocket-Guide-Startup-Valuation-ebook/dp/B00MSZE9NY/ref=sr_1_1?ie=UTF8&qid=[removed to protect privacy]&sr=8-1&keywords=startup+valuation&pebp=1437588457592&perid=0KPZFJA1HGZW7FBFPA3R http://www.amazon.com/Valuing-Start-Ups-Chris-Kern-ebook/dp/B00BPE7R88/ref=sr_1_3?ie=UTF8&qid=[removed to protect privacy]&sr=8-3&keywords=startup+valuation http://www.amazon.com/Mastering-VC-Game-Venture-Start-up/dp/[removed to protect privacy]/ref=sr_1_5?ie=UTF8&qid=[removed to protect privacy]&sr=8-5&keywords=startup+game The last one is pretty good. Good luck and remember that you are in the same boat with the rest of us! R, D-
Patrick Hidalgo
0
0
Patrick Hidalgo Entrepreneur • Advisor
Financial industry executive who is now writing software.
That early on, you might as well use Guy Kawasaki's method:
(# of engineers * $500K) - (# of MBS * $250K)

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