They say an entrepreneur is someone who jumps off a cliff and builds a parachute on the way down, hoping it opens in time.
They are the gladiators of the business world. They are the ones who wake up every morning and go to work so they can create jobs for others…
We have seen and heard too many stories of startups and founders, who raise capital, at such and such valuations, and are billionaires overnight. But how does startup funding work? How do venture capitalists or Angel investors know where to invest or how much or at what valuation?
Let’s see what a startup is worth…
There are 630,000 new businesses formed each year. About 300 of them receive Angel or VC funding, and only 3 of them will go on to become unicorns (companies worth over $1B).
My colleague Jason Gordon, a Silicon Valley attorney who represents venture-backed startups and VCs as they deploy capital, will share what it takes to raise capital in today’s world, so you can be one of the 300, or maybe even one of the top three. Take it away Jason…
If you are looking to raise capital from a traditional venture fund, there are three things you should keep in mind.
- First, those VCS have their own investors.
- Second, those investors have their own set of expectations and
- third, the earlier in the company’s life cycle that a VC invests the greater return VC’s is going to be seeking from that investment because of risk.
Let us unpack those Three Things:
- First VCs have their own investors. They have got maybe pension funds or funds of funds or sovereign wealth funds. Family offices or wealthy individuals that make up their LPS their limited partners.
- Second, those investors have a set of expectations that is typically three X the return on their capital over the life of the fund.
- Third, let us talk about the strategy that a VC deploys in order to get those returns that are necessary to please their investors. The V. C. step strategy is basically this. Sprinkle your seed over a number of investments.
There will be a lot of companies and investments that do not pan up will be a few singles, but it is the big winners that are going to get the returns you need in order to satisfy the expectations of the VC investors.
So, let us talk a little about what a big winner looks like. Well, it is sort of traditionally a company that increases in value by two or three X every 18 to 24 months. So, we would just take a hypothetical deployment of a million dollars by VC at an early stage that is a series seed stage,
- You can see that investment would be worth three million at the Series A
- Nine million at the B
- Twenty-seven million by the c
- Eighty-one million by the D.
And even if that investment were to flatten out before an IPO or M&A to exit. You can see that the early-stage VC could have maybe even 100 X the return on their capital. And that’s kind of what they would need because at earlier stages, much riskier than a later stage company.
So, with that in mind if you’re looking to raise capital from a traditional venture fund, it’s important you keep in mind what the VC’s model is and where you are in your life cycle so that you can give the VC credible information, so they can make the decision when they make that investment. They’re going to get the return.
They need to satisfy their investors, back to you Bharat.
Thanks, Jason…great to have you…
In this episode, I will share with you how Angels and VCs value companies –
Depending on the VC, industry, and stage of the company, there are three ways they value companies –
1. For Seed or Angel Stage. How much are they looking to raise? Take that number, and divide by 10%, and 25%. VC or Angels will not take less than 10%, and not higher than 25% in equity of an early-stage startup. This gives you a good range for the valuation of a company and establishes a starting point.
For example – the first Bitcoin transaction was for a pizza. Someone accepted 10,000 Bitcoins for a pizza, and the value base was established.
2. For Series A or Early Stage. How much was your last round’s valuation? Have you 3-4x your customers or revenue since? If yes, they will give you twice that multiple in valuation for your next round.
For example – if you had said you have 10,000 users and your seed valuation was $1M, and now you have 50,000 users, they will at least give you a $10M valuation if not more.
3. For Growth Stage. What are similar companies in this industry selling for? Say if your competitor just raised capital, what are the terms of that raise, and how does your company’s performance stack against that?
If your competitor just raised $200M at a $10B valuation, how do you stack up against them in terms of stage of development, market traction, and management team?
The most important point here is your first ask. How much are you looking to raise and for how much equity? This always becomes the starting point.
There are four things founders can do to maximize their company’s value –
- Create a product or service with a pre-existing demand. Identify a void in the market and fill it. No point fighting an uphill battle to create a need.
- Recurring revenue – companies that have recurring revenue like Zoom, Salesforce, or DocuSign are the holy grail. Investors love business models that are based on recurring revenue which scales as the customer dependence grows.
- Be a Great Recruiter. A founder that can attract and retain talent is the King. Yes, it’s that simple. Strong and loyal followers are key to any uphill battle.
- Ask and you shall receive – simply ask the VC – what do they need to see happen to double the valuation in the next round. They know. They want to tell you so you can do it. Just ask.
I have been in the venture capital and startup world for over a decade. I have seen many companies go from nothing to Fortune 500, and many going from zero to zero.
Startup valuations are a dark art, in a dark room, in a black box. It is designed this way. So founders are clueless and at the mercy of the investors.
I just gave you a glimpse into that black box…