On October 17th I posted on seed and early stage startup valuations.  This morning I read a post by Marty Zwilling on startup valuations.  Here it is.  Marty’s posts are solid in my opinion – short and content driven.  His post on startup valuations lists the following rules of thumb (i.e., possible inputs) for the calculation (and he explains each):

1. Place a fair market value on all physical assets (asset approach).
2. Assign real value to intellectual property.
3. All principals and employees add value.
4. Early customers and contracts in progress add value.
5. Discounted Cash Flow (DCF) on projections (income approach).
6. Discretionary earnings multiple (earnings multiple approach). .
7. Calculate replacement cost for key assets (cost approach).
8. Look at the size of the market, and the growth projections for your sector.
9. Assess the number of direct competitors and barriers to entry.
10. Find “comparables” who have received financing (market approach).

I was a little surprised that his list did not include the following:

1. Demand for your deal, measured by the number of term sheets you have obtained.
2. The reality that an early stage VC is going to want to typically obtain between 20-35% of your company in the financing (the point of my original post).

I actually think that these 2 are probably the most important.   And just for fun here is my quick take on the others that he did list; these factors will help drive where in the 20-35% range you end up.  Critically, I am only talking about seed and early stage company valuations as opposed to valuations for more mature companies:

1. Place a fair market value on all physical assets (asset approach) – pretty much a waste of your time.
2. Assign real value to intellectual property – only worth something if patents have actually issued or the invention is so unique that the application and eventual patent could really serve to block competitors.
3. All principals and employees add value – the team is very valuable.  The better the team, the better the valuation.
4. Early customers and contracts in progress add value – completely agree that real customers are big boosters.
5. Discounted Cash Flow (DCF) on projections (income approach) – worthless.
6. Discretionary earnings multiple (earnings multiple approach) – worthless.
7. Calculate replacement cost for key assets (cost approach) – worthless.
8. Look at the size of the market, and the growth projections for your sector – sure, big markets are more attractive.
9. Assess the number of direct competitors and barriers to entry – see number 2 above.
10. Find “comparables” who have received financing (market approach) – very difficult to ascertain as the information is well guarded and the media is usually wrong on this one.

Add to the list……

I hosted a guest lecturer today named Doug Rowan at Johnson (for those of you not in the Cornell ecosystem, “Johnson” is how the marketing department likes us to refer to Cornell’s business school).  Doug is an older guy with lots of startup experience both as entrepreneur and investor.  He currently mentors a lot of companies at the “tiny” stage.

Doug’s lecture was on startup company valuations.  Here was his key takeaway:  the best way to look at valuations of seed or Series A companies is to consider the amount being raised and the fact that the investors will want to own between 20% – 35% of your company after they invest (assuming a priced equity round).  Period, the end.  Yeah, it is that simple.

So, you want to raise $500,000, well guess what, your pre-money valuation will be between $930,000 and $2mm.   You want to raise $1mm, then your pre-money valuation will be between $1.857mm and $4mm.  You want to raise $5mm (big first round), well just do the math.

[desired %] = (Amt to be raised)/(X+Amt to be raised)

Just put in the “desired %” and “Amt to be raised” and solve for X.  That is your pre-money (well at least one end of the range).   Doug’s view point is often right.