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Venture Capital
Valuations You've found a potential investor after
many months of searching. He appears to like your project and
sees the potential for everyone to make some serious money on the
deal. You discuss your technology , marketing strayegy,
operational plan, and financing needs. You see eye-to-eye on
practically everything. Then finally, when you are both feeling
comfortable with one another, the question of valuation is finally
broached. How much of your company are you willing to surrender in
exchange for his investment? That's when the "you know what" hits the
fan--everytime. In your best estimation, his money is worth 20%
of your company at best. In his estimation it's worth 51%. In many cases, the discussion grinds to a
halt at this point. To put it bluntly, placing a credible valuation on a startup is impossible. Privately held companies on the sales block are typically valued at a multiple of their historical ODCF (Owner's Discretionary Cash Flow). ODCF is the cash that can go into the owner's pocket after all operating costs are covered for the year. Obviously, since a startup lacks any historical ODCF, which is the basis for an objective valuation, any opinions expressed on startup's valuation by the entrepreneur will be little more than wishful thinking. As a rule of thumb, this is what invariably happens when a startup is seeking seed capital. The entrepreneurs convince themselves, based on discounting future cash flows, that the company is worth today, say, $5 million. So, since they are looking to raise only $500,000 the investor providing that sum should be happy to settle for 10% of the equity. Then when they start talking with a serious investor, they discover that he expects 50 or 51% of the equity for his money. That's the magic number for most investors these days. Fifty percent, no matter what the required sum is. It can be $50,000, or $500,000, or $5,000,000, the investor always wants 50 or 51%. Read more on negotiations here. Important Terms to Know Every capital seeker needs to understand these two terms. Pre-money valuation: venture capital terminology for the valuation given to a company by a venture capital firm before it puts money into it. For example, a start-up is valued on a pre-money basis at $4 million. After $1 million is invested the company has a post-money valuation of $5 million with the venture capital firm owning 20%. Post-money valuation: valuation placed on a firm immediately after receiving a round of funding. More advice on valuation negotiations with investors can be found here: Do you set a valuation before talks begin with your investor? Find out how not to turn off potential investors. What are the three best ways to maximize your startup's valuation? Online resources for valuations. |
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