Startup; The assessment of a startup has many moving parts, and things change between rounds. So let's get into the details while also talking about the typical numbers for these types of rides.
I'll go over valuation issues in the order they arise. So we'll go over rating and other considerations that come into play during the Friends, Family, Owners/Seeds, and First Set rounds.
As you move up the capital stack, and because investors are more professional, the terms of the valuation and the deal may change, and you will explain the differences and pros and cons to founders and investors.
Investor friends and family typically write checks ranging from $10,000 to $200,000. They are frequently family members or close personal relationships who have an attachment or affection for the founders and/or the problem that the startup is attempting to solve.
How to value your startup?
There are three stages of a startup: early, venture-funded (growth), and late. The length of each startup stage will vary greatly depending on how well your business is executed, your industry, and your fundraising abilities.
- Startup with Series A funding.
- Angel or seed funding for a startup.
- Qualified financing SAFE.
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1. Startup with Series A funding
The normal ratings you will see on the Friends and Family stage are $500K to $1M. The A range is usually very narrow and the rating is low. The reason for the low valuation is that the risk is enormous.
Many people know that more than 50% of startups fail, so this is a very risky investment. Sometimes you will hear these tours called "Triple Tours" - Friends, Family and Dummies.
While you may have a great idea, a common expression you will hear is that “ideas are a dime a dozen and it’s all about execution”… This is just the beginning and execution is the hardest part.
Founders frequently believe that their idea is the "next big thing" with little chance of failure, but this is not the case, and most investors are aware of this.
Even family and friends. When friends and family invest in your startup, it can be structured as convertible currency that converts to equity later on, or it can be done as equity. Actually, it's about the company's worth.
Again, at the idea stage, the typical valuation is around $500,000-$1 million, and the money is frequently raised as a convertible or safe bond. I'll go over convertible and safe notes in greater depth, as well as their relationship to valuation.
2. Angel or seed funding for a startup
You'll usually raise your Angel/Seed round after your Friends & Family round. Typically, angel investors write checks ranging from $50,000 to $2 million. However, the typical check size will be between $50,000 and $200,000, with some variation above and below.
Angel investors frequently do not have a personal or family relationship with the founders, but may be emotionally attached to the problem being solved or have worked in the field. At this point, most valuations range between $1 million and $3 million, representing 10%-20% of the company.
Again, similar to the Friends and Family round, these are often convertible banknotes or a safe-type structure that converts in a later round — later, larger equity, and that leads to a "qualified financing or QF" when you reach a "Money raised threshold."
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3. Qualified financing SAFE
Now that I've mentioned convertible notes and SAFEs a few times, let's get into them because they have a strong interaction with valuation.
You are about to see that evaluation does not exist in a vacuum, and I will return to this point several times.
A convertible bond (or convertible debt) is principal that starts out as debt and converts to equity upon the next round of "eligible financing," which is whichever is lower: the discount rate or the bond ceiling.
It is critical that you understand the discount rate and ceiling terms. Convertible note investors are offered a lower price for the next round via the "Discount Rate" than other investors.
This is the point at which convertible investor funds are converted into equity in the next funding round. The most common rate of discount is 20%.
This discount compensates investors who invest early in the company for the significantly increased risk they face. Then there's the valuation cap, which imposes a "catch" on the company in the following equity round.
What is investor protection valuation?
The valuation protects the investor by lowering the cap, which means the investor gets a better deal. This prevents 'quick' valuation because convertible bonds took on very high risk at an early stage, and investors want to ensure they can convert into a meaningful portion of equity in the next stock. circular.
Other important terms to understand when it comes to convertible banknotes include the maximum and discount rate.
When it comes to convertible notes, the "maximum" is frequently the "guideline" for valuation. When a startup announces that it will raise an initial $1 million through a $10 million cap convertible note, it implies a $10 million valuation.
This is a "can't pass" number, but it is information, and the higher the number, the less appealing it is to an early stage investor. So remember that.
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Safe/Convertible Securities
The Safe Simple Stock Futures Agreement is another important and more adaptable structure for discussion. It is a convertible security, not a convertible security.
There is no interest rate, no maturity date, and no repayment requirements with Safe/Convertible Securities. SAFE friendliness is more important to the founder.
Because it is not debt, if the company fails, the money is not owed to the investors, and, like convertible bonds, SAFE has discount and cap rates, allowing you to postpone the full valuation discussion.
Valuation of convertible securities in relation to safe securities
Now consider the interaction and valuation of convertible securities and safe securities. Consider this: if you have a term sheet for $1 million in convertible notes (loan, repayable) with a $5 million cap and another term sheet for SAFE (convertible security, not a note or loan) with a maximum valuation of $5 million or possibly $4.5 million, which offer would you accept?
All else being equal, if they're the same cap, you want the security because it's safer for you. However, if the valuation cap is a little lower, say $4.5 million (all else being equal), you may still want to consider the safe position so that there are no debt obligations if things go wrong. Evaluation does not take place in a vacuum.
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Founders, and investors advice
Before we go any further, let me share with you a few other things you should think about when evaluating your startup. What happens, for example, with the group of employee stock options? Is it delivered before or after the funding?
Do you get diluted when the stock option pool is replenished, or does the pool replenish after the funds arrive, causing everyone to be diluted? This will have an effect on your effective valuation.
What additional rights or constraints does the investor impose on the startup? For example, if your startup wants to write a check or sign a contract worth more than $20,000, the investor may need to approve it.
Deal terms are heavily influenced by liquidation preferences. For example, is the investor requesting a 2x liquidation preference? A 1x preference is the typical liquidation you should seek.
You might receive an offer or term sheet with a slightly lower valuation but better terms for your stock option pool. As a result, a slightly lower valuation may represent a better overall deal for founders and startups.
The last major issue I'd like to bring up is that we've seen founders bite them in the a$$ and catch them off guard. Assume you and your co-founder own the entire company. You're about to raise an initial round of funding, and investors will write a check for $1 million.
Investors want to ensure that you stay somewhere, so they will request that you VEST in your own company equity. Otherwise, they write a million-dollar check, and one of you walks out the door with a large stake in the company he no longer works for. Thank you for the cash and equity, guys.
Investors will require you to invest in equity over a period of 3 or 4 years. Some investors might say you get a 4-year vest, but you also get a 25% credit upfront for the time you've already invested. Like I've said many times before, terms and negotiations can get rather complicated.
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Surround yourself with great lawyers, accountants who've done it before, entrepreneurs, or other highly experienced advisors. If your aunt is a personal injury attorney or your uncle or friend is a divorce attorney and says, 'I'm a lawyer, I'll help you organize and get the deal done,' politely decline their offer.
For early-stage companies that advance to the first and second rounds, your rating will typically be a percentage based on how much you raise.
An investor at this point usually wants to own about 20% of the company, so if you tell me how much you make, I'll tell you what your valuation is based on that percentage.
If you're looking to raise $2 million, your valuation will be around $10 million (20% of $10 million is $2 million).
Can my startup get a higher rating?
surely. Assume this is your third business. The other two strikes have been huge hits for investors, and you're in a great position with an incredible team and a great early catch.
Can you raise $2 million if your company is worth $20 million, $30 million, or even $40 million? This is an option. It is possible, albeit unlikely.
You're talking about "fair market value" and what the market will accept. What does a "reasonable buyer" and "reasonable seller" cost?
You won't get a deal if you set your rating too high and no one can meet it. You can also try to start a bidding war and have more than one investor bid on the term paper.
As a result, there is a chance that the valuation bid will rise. However, in the Start and Pool A phases, the 20% rule usually determines your rating mathematically.
The final point I want to emphasize is that valuation is one of many handles and levers in the deal. Unfortunately, valuation is a major issue that many founders must address.
Remember that, in the end, it is usually the investors who set the cap or price, not you. You can try, but it might not be at fair market value and might be more or less than the price of your tour.
Prices will rise, and the tour will be canceled. You sell more than you want if you lower the price. The greater the level of investor interest, the better the deal and terms.
I hope you found this review discussion on How to Value Your Startup useful and learned some pointers for investors and founders.
