Nivi · April 17th, 2008
A reader asks:
“My question is how do we value a company with no sales? I understand it’s an arbitrary valuation but is there anything we can possibly base it on? Is there a “default” valuation for companies in a seed round?”
We’ll answer this question with some questions (and answers) of our own:
- How much money do we need?
- How do we set a valuation from this budget?
- How do we express our valuation to investors?
- What’s the range for seed round valuations?
- How low do seed round valuations go?
- How much money can we raise in a seed round?
- How much dilution should we expect in a seed round?
1. How much money do we need?
First, figure out how much money you need to run at least two experiments*. Then tack on 3 more months of runway so you can raise another round before you run out of money. This is the minimum amount of money you should raise. For example, let’s say you need $100K.
* Your experiments should be constructed such that a positive result will let you raise more money at a higher valuation.
2. How do we set a valuation from this budget?
Now decide what percentage of the company you will sell for $100K. Pick a number between 10% and 20% of the company’s post-money. You can go below 10% but that probably means your valuation will be too high or you will raise too little money.
For example, let’s say you’re willing to sell up to 15% of the company—that’s your bottom line dilution. This implies a bottom line post-money valuation of $666K.
3. How do we express our valuation to investors?
“First, we think we can make the company significantly more valuable if we raise $100K—that’s our minimum. Second, we’re willing to sell up to 10% of the company.”
10% is your aspirational dilution. It’s the lowest dilution you can justify. It’s the lowest dilution you can say with a straight face.
Notice that you didn’t explicitly state your valuation. Combining the dilution (10%) with the minimum amount you’re raising ($100K) implies a minimum post-money valuation of $1M. But the valuation is not explicit. This gives you room to raise your valuation if you raise more than $100K (and we suggest you raise as much money as possible).
4. What’s the range for seed round valuations?
If $25K buys 1% of company, your post-money is $2.5M—that’s on the high end.
If $25K buys 5% of company, your post-money is $0.5M—that’s on the low end.
5. How low do seed round valuations go?
Y Combinator has set new lows for seed round valuations. They get away with it because they also set new highs for helping seed stage companies.
According to the YC FAQ, they buy about 6% of a company for $15K-$20K. So the post-money valuation of their investments is $250K-$333K.
But don’t fixate on valuation. Low valuations aren’t bad if you keep the dilution down too. 6% dilution is very low if the company makes a lot of progress with $15K-$20K.
6. How much money can we raise in a seed round?
If you sell 20% of your company at a $2.5M post-money, you raise $500K. That’s about the maximum for a seed round. Beyond that is Series A country.
7. How much dilution should we expect in a seed round?
Take as much money as you can while keeping dilution between 15-30% (10%-20% of the dilution goes to investors and 5%-10% goes to the option pool).
Compare this to a Series A which might have 30%-55% dilution. (20%-40% of the dilution goes to investors and 10%-15% goes to the option pool.)
A seed round can pay for itself if the quality of your investors and progress brings your eventual Series A dilution down from 55% to 30% (for the same amount of Series A cash).
Don’t over-optimize your dilution. Raising money is often harder than you expect, especially for first-time entrepreneurs.
Smart investors don’t over-optimize dilution either. They want to buy enough points to own a good chunk of the company. But they want to leave the founders with enough points to keep them highly motivated to build a lot of value for the founders and investors alike.
Finally, if you’ve made it this far, please enjoy the following presentation:
thank you for the great post. it feels good to be assured that we’re on the right track.
Amazing, thank you so much for that.
The article that came before the video was pretty good too.
metarand » Hacking Your First Investment Round // Apr 17, 2008 at 8:39 pm
[…] guys over at Venture Hacks have some good points regarding raising that first round of investment – often called the […]
Good stuff. The best discussion I’ve seen for seed-round valuations yet.
One thing that you didn’t get in to yet is: the value of convertible notes to defer discussions on seed valuations.
Good idea Dharmesh. We’ll revisit it — we need to take a fresh look at it.
We previously wrote about the pros and cons of convertible debt here: http://venturehacks-dev.mystagingwebsite.com/term-sheet-hacks#convertible-debt
Glad somebody finally called out the Y Combo guys. Their touchy-feely lab bamboozles ignorant engineering types into giving away a lot of value. Funny how all of these start-up engineering types like to work directly with VCs; they get taken to the slaughterhouse every time.
Hey Thomas, YC combines low valuations with low dilution and high value add. It’s a reasonable combination! =)
linkblog: Apr 17 | Jackson Miller // Apr 17, 2008 at 11:00 pm
[…] Venture Hacks — How do we set the valuation for a seed round? […]
The Ewing Marion Kauffman Foundation has a great set of articles on this very topic that are worth checking out.
The valuation information I’m still digesting. The video I’ve played 5 times in a row now. Thanks!
Nice article, thanks! The presentation did a great job of expressing the idea in a little dance number.
This could be useful for helping calculate a dollar figure:
http://www.caycon.com/valuation.php
Great timely article. The convertible debt is something that seems very common and easy, but for many experienced angel investors, not an attractive option. I’ve gotten feedback from a few angels that said that even with the discount, it isn’t worth it and that they would rather invest in Series A.
Another comment was that with a convertible, the company and the angels are at odds. The angels want a low Series A valuation, thus they get more equity, while the founders/company want a high Series A valuation, thus give away less to the angels/series A investors.
How does one get around this? Any other interesting structures out there?
Hi Nivi,
Can you please provide more details for: why in seed founding I shouldn’t sell more then 20% of the company. e.g., if we get the sum we need to reach a meaningful milestone, for 30% – and the valuation makes sense – why is that a problem?
Thanks.
There’s no hard rule. Understand that you will have multiple rounds and dilution in each round. Understand that the founders will need enough equity to stay motivated after the Series C. Chris Dixon previously commented that he sold something like 50% of the business in the first round of SiteAdvisor and he was glad for it.
Thank you Nivi, you guys rock!
Also, it would be great for you to discuss the different types of transactions. For example, someone mentioned convertible notes. I am allowing for exchangeable shares because my angels are coming in with the most risk. Why should they just get a discount in the next round? They should get a return right away.
More entrepreneurs should think this way. It has only taken me 5 months to raise the $290K I needed because of the way I structured the deal. We gave 14.5% away to our angels.
Nice approach, thanks for the clear information. If you’d like help with company valuation, Armanino McKenna has a great deal of experience and is a good alternative to the Big 5.
For a company currently raising an angel round, how would one determine its valuation? - Quora // Nov 21, 2010 at 8:24 pm
[…] about.4. When the next round is expected to happen.Insert a dynamic date here Anon User http://venturehacks-dev.mystagingwebsite.com/articles…You should know:Are you going to be raising venture capital in the future?What % of your company are […]
Quora // Nov 23, 2010 at 2:35 pm
What is the Pre Money Valuation for a startup web based company?…
It can be some black magic and a little bit arbitrary, but generally between 10% and 20%. Venture Hacks has a nice article that might help you decide how to value your company here: http://venturehacks-dev.mystagingwebsite.com/articles/seed-valuation…