How can founders value their startup if it’s pre-revenue? Vuk Vegezzi from BV4, a certified startup valuation company, suggests four key valuation drivers to consider when making a valuation of your startup.
This article is based on our webinar about the early-stage valuation that you can now watch on our Youtube channel. If you’re interested in learning about different valuation models, check our first article from this series in which Vuk described two popular models and a custom approach of BV4.
Key valuation drivers can be considered as parameters with the most significant impact on a valuation. Depending on a key valuation driver, the methodologies to calculate the company value could become insignificant or, on the other hand, very useful. Identifying key valuation drivers of a startup is crucial to perform a valuation analysis and it cannot be done without it.
Key valuation driver 1: The company stage
The first step of the valuation process is to understand your company stage. You can’t use the same valuation approach for a company that is about to do an IPO and one that doesn’t have any revenue. Depending on where you are some methods may be very complicated to present to investors such as the DCF in the seed stage.
In the case of the pre-revenue startup, the founders have to rely on the methodology that has been tailor-made for early-stage valuation (such as the BV4 model). The further you go across the business life cycle of the startup, the less this early-stage valuation will be important, and the more you can concentrate on the traditional methods such as the DCF or the Market Comparables.
“Overall, valuation is a simple process. It’s a negotiation between a startup and an investor.”
Key valuation driver 2: Mix the rights ingredients
Finding the right ingredients will drive your valuation up. These are the elements that you, as a founder, have control over. Firstly, the team: you can control the commitment of the team, you can enroll some advisory board if needed and you can find co-founders that will supplement you in terms of skills complementarity.
Secondly, the market. Understand your market, its size, growth, and its trends as well as the competition. Understand your product and be able to explain it to others. Start by defining clear answers to questions such as: is there a clear product-market fit? Is there a customer need? What’s your competitive advantage?
Most importantly: bootstrap as much as possible. It’s very important to bootstrap because it enables you to go to investors with a business case instead of just an idea.
And finally, figure out your business model before talking about valuation. The stronger your business model is, the stronger your valuation could be.
Key valuation driver 3: Understand your needs
The post-money valuation is driven by two factors: the investment you ask for and the equity you offer. Understand your needs from a financial perspective. What is the use of your current funds and what you will do with the money from your next round?
Let’s analyze a typical situation that can be found in the startup ecosystem. A founder named John calculated that he needed EUR 0.5M for his seed round. With this investment, he will be able to meet his budget expectations for the next 12 months. John is willing to give away 20% of his company which results in a post-money valuation of EUR 2.5M and a pre-money valuation of EUR 2.0M (= 2.5M – 0.5M). After talking with a few investors, John realizes that he might need a bit more cash to be safe. He is thinking of EUR 750K but he is not willing to give more than 20% in equity. Of course, this decision affects his valuation: now, John’s startup is worth EUR 3.75M post-money and EUR 3.0M pre-money. Can you see it? There is a distortion in the price of EUR 1.0M between the two pre-money valuations.
This is why a founder must clearly understand its startup’s needs and make sure that when he/she start the fundraising process (or at least negotiation talks), the budget calculations have been done properly. Otherwise, you will end up like John and face the following dilemma: either you must return to the investors you talked with and boost your valuation of EUR 1.0M, or you will have to increase the equity you are willing to give them to maintain the same valuation: instead of 20%, you will have to exchange 27% of your stake in the company: a 7% points increase – a big difference, isn’t it?
“There is no right or wrong valuation. It’s always a reflection of your plan.”
Key valuation driver 4: Be prepared!
If you would like to negotiate the valuation with investors, you need a very clear business plan that sorts out all the aspects of your startup. You must show that you understand your market and competitors and you have a strong financial model. Good preparation can clarify a lot of potential questions and it gives you a good indication of where you stand and how much you can ask in terms of investment capital. Last but not least: build a strong pitch deck that is not overwhelming (feel free to use our Fundsup Pitch Deck Template).
Overall, valuation is a simple process. It’s a negotiation between a startup and an investor. If you want to leave the negotiation satisfied, respect a few simple rules:
1. There is no right or wrong valuation. It’s always a reflection of your plan. The better you prepare, the more you can ask, in a straightforward way.
2. A valuation is never set in stone; it’s a basis of negotiation. Be flexible.
2. Don’t cheat – investors are usually much more experienced than you in terms of startup valuation. They know what they’re doing.
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