The success of your startup depends on more than just a great product or service - understanding how to value your company and negotiate funding can be the key to success.
If you're a founder just starting out, understanding early-stage startup valuations can be a daunting process. It's crucial to know how to value your company accurately and fairly, as it will impact your fundraising efforts, equity distribution, and overall success. In this guide, we'll take a look at the methods used to calculate the company valuation and how to negotiate favorable terms for funding.
At an early stage, startups are often valued based on their potential for growth and revenue, rather than their current financial performance. The pre-money valuation is the value of the company before any investment is made. Once an investment is made, the post-money valuation is calculated by adding the investment amount to the pre-money valuation.
Discounted Cash Flow Method
One commonly used approach to calculate pre-money valuations is the discounted cash flow (DCF) method, which estimates the future cash flows of the company and discounts them back to their present value. This is probably not where you want to start as for most early-stage startups, the value will be relatively low as you don’t have a strong cash flow in the short term.
Comparable Company Analysis
Another method is the comparable company analysis (CCA), which compares the startup to other similar companies in the market. This can be problematic as it is often difficult to find comparable companies. Don’t think that this is a very scientific method and always try to find comparable companies that have a high valuation and be prepared to argue why these companies are a better match than the companies the venture capital company has used to establish your valuation.
The “whatever you can get away with” method
I recommend any early-stage startup to at least try this method and wait for the response. Valuations are not set in stone and can fluctuate based on various factors such as market conditions, investor interest, company performance, your track record, etc. Therefore, come up with a reasonable but high figure (using the other methods to guide you) as a starting point. Ultimately achieving a higher valuation or favorable terms such as ordinary shares over preferential shares, is a negotiation game.