Taking money from a venture capital firm requires a crucial initial step of agreeing to a startup valuation, a procedure which evaluates the worth of the startup. This valuation also affects how much of one’s company one owns. Each founder has different strategies regarding startup valuation as optimizing for a higher valuation can often mean having lesser ownership of the company.
According to investors, the procedure of startup valuation is an art, and there is a set of standard factors that need to be considered before a price tag is attached to a startup. The most important of these standard factors is “demand” which is determined by the number of investors eager to invest money into the company.
An entrepreneur can influence valuation in many ways, besides actually creating something that is genuinely valuable. The larger number of investors the entrepreneur pitches to and the better he is at attracting people with his pitch, the bigger is the interest generated thus driving up the price.
Startup valuation is generally set in accordance to the return expected by the investor. If the seed round is $1000 and the investors want a 20 times return, the valuation is likely to be set at $20000.
Investors can never be expected to be arbitrary and vague with valuations. When they are buying a part of a company as investors, they want the valuation to be perfectly accurate.
Important points an investor must analyze while making a startup valuation:
1. Demand or Competition: VCs are fiercely competitive and consider an investment to be valuable if other VCs in the business domain find it worth showing interest. One needs to understand how a VC works, in order to raise money, and it is also one of the most influential factors that influence startup valuation. It is nothing but basic economics, which calculates the maximum number of investors who can be accommodated in a startup’s fundraising round, and if more than this maximum number of investors desire to invest, it results in a higher valuation.
2. Growth: One of the most important factors of a startup valuation is growth. Some entrepreneurs project their growth potential in their pitches, at the time of fundraising, while others are actually able to show growth taking place. Growth potential can be projected by showing the existence of a large market while actual growth can be shown by exhibiting the fast-rising number of paying customers or expanding volume of month-to-month active users. The growth-metric helps in making quite accurate revenue predictions which play a vital role in evaluating the worth of a company.
A VC must always remember during a startup valuation that a market’s potential cannot be always predicted perfectly, particularly if the market is undergoing a number of changes.