Venture Valuation

Startups raise venture capital at valuations based on market norms and qualitative and some quantitative factors. In our view, startup valuations are more an art than a science.

The most common method for startup valuations is comparable transactions or market norms. Many law firms publish quarterly valuation statistics for venture investments by venture round (A, B, C, etc.). VentureSource owned by Dow Jones also published valuation data for is subscribers. For better or worse, a startup’s valuation is influenced by its sector and focus. If the startup is in a hot sector, its valuation will be higher. Conversely, a startup in a weaker sector will have a lower valuation.

A startup should use multiple methodologies in computing its valuation because those methodologies will help it argue for a higher valuation with investors.

Factors that Affect Valuation

Team

• A rockstar team comprised of founders who have had significant prior exits will be able to raise capital at higher valuations. For later stage startups, the team becomes a less important factor in valuation.

Traction

• Traction has a direct correlation to valuation and is particularly important for later stage startusp. Every fundable startup is formed to get users, sell advertising, generate revenue and profits or some other metric. The greater and faster the growth and traction, the higher the valuation. Rocketships like Tumblr received very high valuations based on their user growth.

Revenues

• The later the stage of the startup, the more important revenues and profits are to the startup.

Sector

• Investors are lemmings. If the startup’s sector is hot, it will receive a higher valuation because there will be more investor interest. Economics 101 says that as demand increases, prices increase. Startup valuations follow the same basic economic rules.

Geography

• Startups in tech communities, such as the San Francisco Bay Area and Seattle, receive higher valuations on average than startups located outside the established tech hubs.

Analytical Valuation Methodologies

Venture Capital Method

• The valuation is calculated by estimating the exit valuation and then discounting the exit value by the expected IRR over the time period to exit (average IPO is currently 10 to 11 years).

Common Valuation Terms

There are a number of concepts in venture valuation as follows:

            Pre-Money Valuation + Investment Amount = Post-Money Valuation

            Price/share= Pre-Money Valuation/Fully Diluted Shares Outstanding

Pre-Money Valuation (or Pre-Financing Valuation) is the valuation of the startup immediately prior to the VC investment. The pre-money usually includes a reserved and unallocated option pool sufficient for 12 to 18 months of hiring. A customary unallocated option pool is equal to 20% of the post-money shares outstanding.

Investment Amount

• The amount to be raised in the financing round.

Post-Money Valuation (or Post-Financing Valuation)

• The valuation immediately after the closing of the VCs’ investment.

Fully Diluted Shares Outstanding

• This means all shares of stock outstanding, all options and warrants to purchase stock outstanding on an as exercised basis, all rights to purchase stock on an as-converted and as-exercised basis and all shares that are reserved and unissued under the startup’s stock option plan.