how to calculate the value of your startup

Hey there,

This week we’ll recycle a topic that keeps coming back in our discussions with founders: the startup valuation.

How do you come up with a value number for your startup before starting raising money? It’s hard for two reasons:

1. it can be an ego thing - ‘the startup is my baby’ - and this makes people to impulsively overvalue it.

2. math is not straightforward - an asset that generates little to no revenue makes it difficult for professional investors to use a standard evaluation process, such as calculation of the stream of discounted cash flows.

Still, you gotta find a reasonable valuation number that’s acceptable for both the seller (startup) and the buyer (investor). A few suggestions:

1. Top down approach Decide how much money you will be asking and how much equity you want to sell. Assuming you need $1 million and you want to sell 20% of your company’s shares, that means you’re expecting a company valuation of $5 million, pre-money.

2. Bottom up approach Decide what you try to accomplish by raising money, in a tangible way that’s easy to put a number behind it. Examples of such milestones include launching the 1.0 version of a product, opening a new market, or getting to 100k paying customers, or to $1 million ARR. Once you settle for this specific objective, work your way up the market - that means you should calculate how much money you need to get there, ideally in a spreadsheet detailing a cost structure that supports your go-to-market strategy. Correlate the number with your objective and with the first approach detailed above.

3. Benchmark the market Research what other startups raised at your stage, in your industry, and/or with your business model.

And yet another way to look at it - if your startup doesn’t have a sales record and paying customers, your pitch should focus on selling conviction and not numbers. Conviction combines the opportunity you are trying to pursue with the supporting elements that make it an interesting story: the market dynamics, the total addressable market, the customers or the current industry trends. And, more important, why you, of all people, are the one to turn the opportunity into a multi-million business.

Go through each of the above and play with the numbers. Use a spreadsheet to create scenarios and figure out what’s acceptable for you and it’s feasible to negotiate with potential investors. Settle for a high and a low range, that you can later test against investors appetite when you pitch them.

Let me know how that works and if you have questions - or better off, join Project Arrow, where we can dig through more specifics based on the details of your startup.

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