How to value your startup

this video is brought to you by our new investor finder get weekly investor matches in your industry your company stage and your location delivered to your email for free sign up with the link in the description when you speak to early stage founders they often don't understand how they can either determine a reasonable valuation for their friends and family seed or series a round or judge if an offer they receive is fair and reasonable there are a lot of moving parts to valuation and things vary across rounds so let's get into the details and also cover what typical numbers look like for these types of rounds i'll talk about valuation issues in the order things come up so we'll talk about valuation and other factors at play during a friends and family angel seed and series a round as you go further in the capital stack and as investors tend to be more professional valuation and deal terms can and do change and i'll make sure to point out the differences and pros and cons for both founders and investors typically friends and family investors are writing checks of ten thousand to two hundred thousand dollars often their family members or close personal connections who feel an attachment or affection to the founders and or the problem the startup wants to solve the normal valuations you'll see at the friends and family stage are about a half a million to a million dollars typically the range is pretty tight and the valuation is low the reason the valuation is so low is that the risk is enormous many people know that over 50 of startups fail so this is an extremely high risk investment sometimes you'll hear these rounds termed triple f rounds friends family and fools while you may have a great idea the common expression you'll hear is that ideas are a dime a dozen and it's all about execution you very well could have a great idea but that's just the beginning and it's the execution that's the hardest part founders usually think their idea is the next big thing and there's little chance of failure but this just isn't the reality and most investors know that even friends and family when friends and family investors put money into your startup it could be structured as a convertible note which converts to equity of the later stage or could be done as equity by using a convertible note you can delay the valuation discussion about what the company is actually worth again a typical valuation at the friends and family idea stage is around a half a million to a million dollars and often money is raised as a convertible note or safe i'll get into convertible notes and safes in more detail in a bit as well as their interplay with valuation so after you've raised your friends and family round you'll typically raise your angel or seed round angel investors usually write checks ranging from about fifty thousand dollars all the way up to two million dollars but more typically the check size will be somewhere between fifty thousand dollars and two hundred thousand dollars with some variation higher or lower often angel investors don't have a personal or family connection to the founders but they may have an attachment to the problem being solved or have worked in the domain valuations you'll see at this stage are typically between one million and three million dollars and that's usually for ten to twenty percent of the company again like a friends and family round often times this is a convertible note or safe type structure that converts at a later round a later larger equity round that triggers a qualified financing or qf when you hit a funds raised threshold i've now mentioned convertible notes and safes several times so let's get into those as they have a very strong interplay with valuation you're about to see that valuation does not live in a vacuum a point i'm going to come back to several times a convertible note or convertible debt is capital that begins as debt and converts into equity upon a next qualified financing round at whichever is less the discount rate or the node's cap discount rate and cap are super important terms to make sure you understand convertible note investors are offered a lower price via discount rate to the next round than other investors this is when the convertible note investors funds turn into equity at the next financing round the most common discount rate you see is 20 this discount compensates investors who came in earlier in the company's life for the highly increased amount of risk they're taking on we then have the valuation cap which puts a maximum not to exceed valuation on the company for the next equity round valuation caps offer dilution protection to an investor the lower the cap the better the deal and investor gets for the investor this prevents a runaway valuation where in the very early stage convertible note they took extremely high risk and they want to make sure that they can convert into a meaningful portion of equity in the next equity round there are other important terms to understand about convertible notes but cap and discount rate are the most important ones when dealing with convertible notes and taking that back to the subject of this video often times that cap we've been talking about is a tell on valuation if a startup says they're raising a seed round of one million dollars via convertible note with a 10 million dollar cap they're implying a valuation of about 10 million dollars that's a not to exceed number but it's definitely a tell and the higher that number goes the less interesting it is to an early stage investor so keep that in mind to drive that point home this is why many early stage investors won't invest in uncapped notes because they have no idea what that valuation could be in the next round and if they're going to get diluted to almost nothing there's one other very important and more flexible structure to talk about and that's a safe or simple agreement for future equity this is a convertible security not a convertible note a safe convertible security has no interest rate no maturity date and no repayment requirement safes are more founder-friendly since it's not debt if the company would go under the funds are not owed to investors and similar to convertible notes safes have discount rates and caps so you can still defer the full valuation discussion so now let's think about the interplay of convertible notes and safes and the topic of this video valuation think about this if you received a term sheet for one million dollar convertible note with a five million dollar cap and then we're lucky enough to get another term sheet from another investor for a safe so convertible security not a note or a loan with a five million dollar or maybe even four million dollar valuation cap which offer would you take if they were the same cap and all things being equal you would want the safe since it's safer for you no pun intended but if the valuation cap were a little bit lower on the safe say four and a half million dollars you may still want to consider the safe so if things go sideways there is no debt liability valuation does not live in a vacuum before we go on let me share a few more things you should seriously consider as you think about valuation for your startup for example what happens with your employee stock option pool does it come before or after the financing comes in so do just you the founders only get diluted when the stock option pool is replenished or does the stock option pool get replenished after the funds come in so everyone gets diluted this has an impact on what your effective valuation will be what other things are at play that are tied closely to valuation but are not directly called valuation how about what additional rights or restrictions is the investor putting on the startup for example if your startup wants to write a check or sign a contract over twenty thousand dollars maybe the investor has to sign off on that you're giving the investor much more day-to-day control over your startup you thought you were running the show but maybe not so based on other terms that are baked into the agreement another big factor in deal terms to think about liquidation preferences for example is the investor asking for a 2x liquidation preference meaning if there's an exit the investor gets back two times the money they put in before anyone else gets their money back by the way the typical liquidation preference you should be looking for is a 1x liquidation preference so you might get an offer or term sheet with a slightly lower valuation but with more favorable terms regarding the employee stock option pool liquidation preferences and other rights so the slightly lower valuation may be a better overall deal for the founders and the startup the last big issue i want to point out that we've seen by founders in the ass and caught them off guard founder vesting let's say you and your co-founder own 100 of the company you're about to raise a seed round and investors are going to write a check for 1 million investors want to make sure you're going to stay around so they're going to ask you to vest into the equity of your own company otherwise they could write you a check for a million dollars one of you walks out the door and now owns a large percentage of the company that they're no longer working for thanks gents for the cash and equity let me know how it all turns out not something an investor ever wants to let happen what's typical investors will ask you to vest over a three to four year period into the company some investors may say you get a four year vest but you also get a 25 credit for the time you've already put in for time served like i've said many times before the terms and negotiations can get fairly complex when working on deals like this bring your a team and your a game surround yourself with great attorneys or accountants who've done this before or other entrepreneurs or advisors who are highly experienced in these issues and by the way if your aunt is a personal injury attorney or your uncle or friend is a divorce attorney and says hey i'm a lawyer i'll help you do this and get it structured and done politely decline their offer and bring in that a team that has a ton of experience on these particular types of issues okay as we get closer to your series a i want to talk about how valuation becomes more mathematical based on some pretty standard ratios that are usually tied to one key thing how much are you raising in a recent dream of dose we talked about how to figure out how much to raise often this is a confusing topic for founders and they're not exactly sure how to figure this out anyway for early stage companies moving into seed and series a rounds your valuation is usually going to be a ratio based on how much you're raising typically an investor at this stage wants to own about 20 percent of the company so if you tell me how much you're raising i'll tell you based on this ratio what your valuation is if you're trying to raise a two million dollar seed round i'm going to tell you that your valuation is going to come in at around 10 million dollars 20 of 10 million dollars is 2 million now that's just a rough rule of thumb could you get a higher valuation sure let's say this is your third startup the other two have been huge hits that drove great investor returns and you're working in a hot space with an amazing team and great early stage traction could you raise two million dollars at a 20 million or even 30 million dollar evaluation sure it's possible not probable but possible what you're working with here is fair market value and what the market is willing to bear what's the price a reasonable buyer and reasonable seller come to if you go too high on your valuation and no one will meet it you won't get a deal done further you could try to get a bidding war going and get more than one investor offering a term sheet so there is a chance the valuation gets bit up but what we typically see at the seed in series a stages is that the 20 rule mathematically determines your valuation now the final point i want to reemphasize here is that valuation is just one of the many knobs and levers in a deal unfortunately it's valuation that seems to be the big issue that most founders fixate on they almost get tunnel vision around valuation they're almost thinking about how their tech crunch headline is going to read but be super careful here otherwise you can get taken to the cleaners on many other terms founder investing employee stock option pool liquidation preferences and other investor rights keep in mind that at the end of the day investors will typically set the capper price not you you can try but you may not be at the fair market value and you may over price or under price your round over price and the round won't close under price and you may have sold more than you needed to the more investor interest you can generate the better deal terms you'll get i hope you found this valuation discussion helpful and if you did please like and subscribe to the slide bean and dream adventures youtube channels thanks for watching [Music] you

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Keywords: slidebean, caya slidebean, company forensics, caya, startups, startups 101, startup valuation, startup funding, how to value a company, how to value a startup, valuation of a company, venture capitalist, startup company, valuation, raise money, fundraising, founder vesting, entrepreneur, company valuation, startup funding 101, pitch deck, convertible notes, raising capital, investors, startup valuation model, how to valuate, steve barsh, dreamit, business valuation

Id: BXUIaOMVIqc

Length: 12min 59sec (779 seconds)

Published: Thu Jan 14 2021