Valuations: It’s Black Magic
Are you raising more than $50K? If so read on…….
When you start capital raising, one of the most important numbers in the process is the “pre money valuation” of your business.
Set it too low and you give away too much.
Set it too high and you make it extremely difficult to capital raise the next time around, as you create the real risk of a lower price than the post money valuation.
What does pre money valuation mean? This is how much your venture is worth, before any new money is tipped in. The main purpose is to figure out how much of your venture you will sell them for the money they tip in.
Let’s say you’re raising $500K at a pre money valuation of $2m. The post money valuation is $2.5m ($2m pre money + $500K cash).
The amount of equity the new investors will receive is 20%, being $500K / $2.5m.
There’s a golden rule in valuations for any asset that applies here:
“It’s worth what someone’s prepared to pay for it”
What we can’t do today is tell you how much your venture is worth as there is no buyer in this conversation who can answer that question. This applies just as much to technology assets as to buying a house.
What we can do is talk about some of the triggers which are used by investors to value the asset.
They will always ask you what you think it’s worth. They will always make up their own mind, and they may not tell you how they got there.
It’s a bit like dating – you put your best foot forward, it comes down to how much the other person wants what’s on offer in terms of how much they’ll put their best foot forward.
WHAT YOU NEED TO KNOW
For ventures which are pre-revenue or pre cashflow positive, the best way to establish a range of what you think it may be worth is to see what similar ventures are getting in their capital raising activities.
These are the factors that you may not have full control over, however change how potential investors perceive your venture considerably:
– If you’re buying a house in California vs Sydney, you would expect the price to be different. The location you are capital raising in does count here.
– If you’re buying a house in a high demand market (such as Sydney has experienced in the last two years) vs a down market (such as California during the GFC), again you would expect the price to be different.
– The last element to consider is whether you’re building an asset with substantial users for advertising (eg: Twitter & Whatsapp) vs a disruptive business model (such as Xero or Uber).
These are the levers you can press which will improve your valuation, compared to the prices being achieved by others in the same market location and capital environment (high demand vs down market) as you.
– You have an idea where the market potential is significant
– You have developed an initial MVP, and have either paying customers or substantial user traction, and you can demonstrate the potential for your product to scale
– Your user growth is at least 20% month / month
– Your paying customer growth is at least 20% month / month
– You’ve been actively trading (ie: billing customers) for between 6 to 18 months.
The more of the above list you tick, the higher your pre money valuation will be.
4 METRICS THAT MATTER
How much is your venture worth before money is tipped in.
Amount being raised?
How much are you raising?
% equity being sold?
What % of the company will new investors own for the money tipped in Target valuation at next capital raise?
Is this higher than the post money valuation.
If not – PROBLEM!!!!