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How to value your startup - YouTube
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when you speak to early stage founders
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they often don't understand
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how they can either determine a
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reasonable valuation for their friends
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and family
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seed or series a round or judge if an
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offer they receive is
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fair and reasonable there are a lot of
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moving parts to valuation
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and things vary across rounds so let's
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get into the details and also cover what
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typical numbers look like
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for these types of rounds i'll talk
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about valuation issues in the order
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things come up
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so we'll talk about valuation and other
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factors at play
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during a friends and family angel seed
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and series a round
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as you go further in the capital stack
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and as investors
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tend to be more professional valuation
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and deal terms can and do change
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and i'll make sure to point out the
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differences and pros and cons for both
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founders
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and investors
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typically friends and family investors
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are writing checks of ten thousand to
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two hundred thousand dollars
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often their family members or close
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personal connections
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who feel an attachment or affection to
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the founders and or the problem the
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startup wants to solve the normal
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valuations you'll see
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at the friends and family stage are
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about a half a million to a million
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dollars typically the range is pretty
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tight
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and the valuation is low the reason the
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valuation is so
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low is that the risk is enormous many
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people know that over 50
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of startups fail so this is an extremely
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high risk investment
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sometimes you'll hear these rounds
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termed triple f rounds
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friends family and fools while you may
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have a great idea
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the common expression you'll hear is
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that ideas are a dime a dozen
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and it's all about execution you very
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well could have a great idea
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but that's just the beginning and it's
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the execution that's the hardest part
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founders usually think their idea is the
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next big thing and there's little chance
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of failure
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but this just isn't the reality and most
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investors know that
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even friends and family when friends and
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family investors put money into your
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startup it could be structured as a
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convertible note which converts to
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equity of the later stage
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or could be done as equity by using a
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convertible note you can delay
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the valuation discussion about what the
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company is actually worth
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again a typical valuation at the friends
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and family idea stage is around a half a
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million to a million dollars
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and often money is raised as a
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convertible note or safe i'll get into
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convertible notes and safes in more
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detail in a bit
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as well as their interplay with
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valuation so after you've raised your
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friends and family round
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you'll typically raise your angel or
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seed round angel investors usually write
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checks
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ranging from about fifty thousand
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dollars all the way up to two million
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dollars
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but more typically the check size will
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be somewhere between fifty thousand
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dollars and two hundred thousand dollars
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with some variation higher or lower
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often angel investors don't have a
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personal or family connection to the
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founders
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but they may have an attachment to the
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problem being solved or
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have worked in the domain valuations
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you'll see at this stage are typically
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between one million and three million
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dollars and that's usually for ten to
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twenty percent of the company
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again like a friends and family round
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often times this is a convertible note
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or
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safe type structure that converts at a
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later round
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a later larger equity round that
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triggers a qualified financing or qf
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when you hit a funds raised threshold
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i've now mentioned convertible notes and
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safes several times
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so let's get into those as they have a
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very strong interplay with valuation
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you're about to see that valuation
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does not live in a vacuum a point i'm
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going to come back to
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several times a convertible note or
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convertible debt is capital that begins
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as debt and converts into equity
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upon a next qualified financing round at
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whichever is
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less the discount rate or the node's cap
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discount rate and cap are super
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important terms to make sure you
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understand
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convertible note investors are offered a
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lower price via discount rate
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to the next round than other investors
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this is when the convertible note
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investors funds turn into equity at the
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next financing round
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the most common discount rate you see is
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20 this discount
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compensates investors who came in
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earlier in the company's life
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for the highly increased amount of risk
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they're taking on
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we then have the valuation cap which
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puts a maximum
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not to exceed valuation on the company
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for the next
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equity round valuation caps offer
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dilution protection to an investor
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the lower the cap the better the deal
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and investor gets
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for the investor this prevents a runaway
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valuation where in the very early stage
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convertible note they took extremely
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high risk
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and they want to make sure that they can
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convert into a meaningful portion of
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equity in the next
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equity round there are other important
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terms to understand about convertible
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notes
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but cap and discount rate are the most
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important ones
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when dealing with convertible notes and
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taking that back to the subject of this
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video
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often times that cap we've been talking
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about is a tell
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on valuation if a startup says they're
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raising a seed round of one million
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dollars via convertible note with a 10
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million dollar cap
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they're implying a valuation of about 10
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million dollars that's a
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not to exceed number but it's definitely
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a tell and the higher that number goes
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the less interesting it is to an early
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stage investor
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so keep that in mind to drive that point
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home this is why many early stage
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investors won't invest in
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uncapped notes because they have no idea
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what that valuation could be in the next
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round and if they're going to get
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diluted to almost nothing
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there's one other very important and
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more flexible structure to talk about
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and that's a safe or simple agreement
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for future equity this is a convertible
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security not a convertible note
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a safe convertible security has no
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interest rate
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no maturity date and no repayment
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requirement
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safes are more founder-friendly since
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it's not debt if the company would go
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under
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the funds are not owed to investors and
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similar to convertible notes
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safes have discount rates and caps
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so you can still defer the full
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valuation discussion
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so now let's think about the interplay
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of convertible notes and safes and the
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topic of this video
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valuation think about this if you
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received a term sheet
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for one million dollar convertible note
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with a five million dollar
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cap and then we're lucky enough to get
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another term sheet from another investor
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for a safe
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so convertible security not a note or a
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loan
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with a five million dollar or maybe even
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four million dollar valuation cap
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which offer would you take if they were
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the same cap and all things being equal
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you would want the safe since it's safer
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for you no pun intended but if the
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valuation cap were a little bit
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lower on the safe say four and a half
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million dollars you may still want to
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consider the safe
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so if things go sideways there is no
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debt liability
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valuation does not live in a vacuum
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before we go on
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let me share a few more things you
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should seriously consider
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as you think about valuation for your
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startup for example
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what happens with your employee stock
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option pool does it come before or
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after the financing comes in so do just
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you the founders only get diluted when
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the stock option pool is replenished
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or does the stock option pool get
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replenished after the funds come in
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so everyone gets diluted this has an
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impact
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on what your effective valuation will be
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what other things are at play that are
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tied closely to valuation but are not
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directly
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called valuation how about what
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additional rights or restrictions is the
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investor
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putting on the startup for example if
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your startup wants to write a check or
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sign a contract over twenty thousand
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dollars
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maybe the investor has to sign off on
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that you're giving the investor
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much more day-to-day control over your
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startup you
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thought you were running the show but
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maybe not so
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based on other terms that are baked into
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the agreement another big factor in deal
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terms to think about
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liquidation preferences for example is
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the investor asking for a 2x liquidation
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preference
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meaning if there's an exit the investor
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gets back two times the money they put
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in
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before anyone else gets their money back
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by the way the typical liquidation
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preference you should be looking for
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is a 1x liquidation preference so you
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might get an offer or term sheet with a
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slightly
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lower valuation but with more favorable
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terms regarding the employee stock
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option pool
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liquidation preferences and other rights
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so the slightly lower valuation
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may be a better overall deal for the
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founders
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and the startup the last big issue i
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want to point out that we've seen by
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founders in the ass
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and caught them off guard founder
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vesting let's say you and your
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co-founder own 100 of the company
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you're about to raise a seed round and
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investors are going to write a check for
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1 million
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investors want to make sure you're going
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to stay around so they're going to ask
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you to vest into the equity of your own
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company
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otherwise they could write you a check
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for a million dollars one of you
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walks out the door and now owns a large
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percentage of the company that they're
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no longer working for
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thanks gents for the cash and equity let
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me know how it all turns out
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not something an investor ever wants to
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let happen what's typical
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investors will ask you to vest over a
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three to four year period into the
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company
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some investors may say you get a four
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year vest but you also get a 25
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credit for the time you've already put
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in for time served
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like i've said many times before the
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terms and negotiations can get fairly
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complex when working on deals like this
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bring your a team and your a game
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surround yourself with great attorneys
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or accountants
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who've done this before or other
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entrepreneurs or advisors
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who are highly experienced in these
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issues and by the way if your aunt is a
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personal injury attorney or your uncle
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or friend is a divorce attorney and says
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hey i'm a lawyer i'll help you do this
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and get it structured and done
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politely decline their offer and bring
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in that a team
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that has a ton of experience on these
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particular types of issues
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okay as we get closer to your series a i
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want to talk about how valuation
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becomes more mathematical based on some
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pretty standard ratios
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that are usually tied to one key thing
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how much
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are you raising in a recent dream of
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dose we talked about how to figure out
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how much to raise often this is a
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confusing topic for founders
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and they're not exactly sure how to
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figure this out anyway
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for early stage companies moving into
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seed and series a rounds your valuation
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is usually going to be
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a ratio based on how much you're raising
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typically an investor at this stage
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wants to own about 20 percent of the
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company
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so if you tell me how much you're
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raising i'll tell you based on this
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ratio
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what your valuation is if you're trying
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to raise a two million dollar seed round
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i'm going to tell you that your
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valuation is going to come in at around
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10 million dollars
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20 of 10 million dollars is 2 million
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now that's just a rough rule of thumb
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could you get a higher valuation sure
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let's say this is your third startup the
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other two have been
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huge hits that drove great investor
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returns and you're working in a hot
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space with an amazing team and
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great early stage traction could you
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raise two million dollars at a 20
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million or even 30 million dollar
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evaluation
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sure it's possible not probable but
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possible what you're working with here
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is fair market value and what the market
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is willing to bear
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what's the price a reasonable buyer and
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reasonable seller come to
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if you go too high on your valuation and
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no one will meet it
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you won't get a deal done further you
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could try to get a bidding war going
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and get more than one investor offering
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a term sheet so there is a chance the
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valuation gets bit up
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but what we typically see at the seed in
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series a stages
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is that the 20 rule mathematically
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determines
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your valuation now the final point i
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want to reemphasize here is that
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valuation is just
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one of the many knobs and levers in a
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deal unfortunately
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it's valuation that seems to be the big
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issue that most founders fixate on they
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almost get
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tunnel vision around valuation they're
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almost thinking about
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how their tech crunch headline is going
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to read but be super
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careful here otherwise you can get taken
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to the cleaners on many
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other terms founder investing employee
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stock option pool
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liquidation preferences and other
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investor rights keep in mind that at the
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end of the
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day investors will typically set the
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capper price not
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you you can try but you may not be
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at the fair market value and you may
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over price
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or under price your round over price and
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the round won't close
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under price and you may have sold more
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than you needed to
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the more investor interest you can
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generate the better deal terms you'll
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get
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i hope you found this valuation
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discussion helpful and if you did
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please like and subscribe to the slide
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bean and dream adventures youtube
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channels
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thanks for watching
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[Music]
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you
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