Today I gave a presentation to Funding Universe subscribers describing the valuation of a startup across stages of development.
The theme comes from a metaphor I heard Ron Poelman use in a speech: valuations of early stage businesses come down to dividing the pie.
Founders: So, when the founders sit down to decide how many shares they each should get, the process is rarely a function of math and is more often a simple discussion of what feels equitable.
Friends and Family: With friends and family, the founders typically set a price arbitrarily that the friends and family accept. This makes sense because there is typically so little basis on which to value a business this early.
Angels: Typically, the value of a business at the angel investor stage is negotiated, focusing on creating a win-win scenario in which management remains sufficiently motivated to work while the investors are compensated for taking risk.
Venture Capital: In the early rounds of venture capital, there remain relatively few bona fide metrics on which to base a traditional valuation analysis. For instance, if there is little or no revenue and no profits or cash flow, most traditional metrics won't work. The focus becomes subjectively assessing the company's prospects for growth and the future capital requirements that will dilute current owners. While somewhat more analytical than prior rounds, early venture rounds still come down to making sure that the management retains enough equity to be highly motivated to work and for the investors to be compensated for their risk.
Let me share one story by way of example:
I recall one client that had sold shares in the company (before Thorpe Capital was involved) at a pre-money valuation of $10 million. At that point, the company didn't have so much as a prototype. The company did build a preliminary version of a fine web site, but not surprisingly it was unable to raise any more money from investors sophisticated enough to provide the required capital because they could recognize that this business wasn't worth anywhere close to the $10 million valuation.
I'd love to get your stories about negotiating your rounds of capital. What have you learned?
I remember going before a group of angels here in Utah a number of years back, and when asked what we thought our valuation to be, we answered "$4M". From the shadows someone quipped "everyone thinks they're worth $4M". It was a rude remark as it was curt and dismissive — ignoring the effort that went into the pro forma. But the remark has stayed with me ever since... and probably not for the reasons one might guess.
In the end, a company is "worth" what the market says it's worth. End of sentance — though not of story. Let's pretend for a moment that it's true that everyone (or even a large share) of the people this * cough * gentleman was seeing were valuating their projects at $4M. Then his dismissive attitude belied a failure to see what that meant: that regardless of what value their ideas eventually captured from the market, that innovators of that era collectively set the bar for their own effort at $4M. Disparate actors coming individually to the same conclusion is not to be laughed at.
Anyway... I'm beginning to ramble... but when you asked for stories, that's what came to mind.
Posted by: Silus Grok | February 26, 2007 6:51 PM | Permalink to Comment