MD asked a question about valuations. There are two kinds of valuations you need to be concerned with when raising money - how much you actually think the company is worth (now or at some exit in the future) and how much the pre or post money valuation will be for the round. In some perfect theoretical world, those two numbers might be similar, but usually they are not remotely related.
I have been asked many times in a first VC meeting about valuation expectations for the round. In my experience, the correct answer to this question is a vague remark that you do not have any hard number in mind, you understand the stage of company you are in, and that you are just looking for something that is reasonable given the stage you are at and market as a whole. I have never, ever, ever named a number. If you get more questions on values or exits, I would just pivot the conversation over to talking about comps - other companies that have recently had exits, what their multiples on revenue was and how that compares elsewhere in the market, and then you can go back to your revenue forecasts.
If a VC perceives that you are hung up over the valuation of the company, they are not going to see you as someone they want to deal with. They want to invest with reasonable people.
VCs will do their own math eight different ways and see what all those numbers add up to for yoru valuation, and then ultimately they will take however much you are raising, and they will want to take somewhere between 25%-50% of your company for that. When you get into later rounds, this math changes, but in early stages, the valuation of your company is MOST dependent not on your product, your revenue forecasts, or the market, but on how much money you are raising. Take the exact same company and raise $1M for it and you are going to have a $1.5M pre-money valuation, and go raise $5M and you will have a $7.5M valuation.
Since the valuation is basically completely out of your control as an early stage company founder, just forget about it. The truth is, it really doesn't matter a whole lot to you. As a founder, you own a HUGE part of the company, and if the company is even modestly successful, you will make a boatload of money, and if the company fails or just barely eeks an exit out, you aren't going to get much out of it. The only time the valuation will really matter for you is when you end up in that purgatory of exiting for something but not a ton more than what you've raised in capital, and in that case things like preferences are a whole lot more important than the valuation, so THAT is what you should really be caring about.
To get into a discussion with a VC in early meetings about the valuation is a big mistake. The negotiation over the valuation really doesn't begin until you get a term sheet. It is pointless to argue about it anyways before that, because they'll just screw you on the terms like preferences before you've seen them (but funny I've never had a VC ask me what preferences I was anticipating in my first VC meeting). The only way to really make a massive change in a valuation is to have multiple term sheets to play off each other. If you don't have that, then you are going to have a relatively modest range to negotiate, but by the time you've gotten a term sheet, you have a firm that is REALLY interested in your company, and to the extend you are being reasonable and level-headed, they are going to show you a little wiggle room just to kick off the relationship on a real positive foot.
Most first-time founders would have already sold their company for the amount of the pre-money valuation investors will offer them, if they could have done so. This leads to a real, but unspoken, conflict between founders and investors, as the investors absolutely have no interest in selling a company for no profit. As the company grows, new employees and new management gets stock options, which on top of the preferences of the investors and the small amount of stock they have makes a small exit very unappealing to them as well. Eventually, the will of the founder in this regard is squashed. Since nobody wants a founder who has such a small goal that is obviously in conflict with everyone else involved in the company, you should do everything possible to conceal the fact that this was ever true. Harping on the valuation is one way that VCs sniff out founders who are thinking small.
My final thought... don't fool yourself to think that the valuation a VC firm gives you has any bearing on how much your actual company is worth.
I'm not planning on commenting on all the different ways you can value a company or how a VC might do the math or explaining what a valuation is. If you are interested in that, some links: http://www.ventureblog.com/articles/indiv/2003/000200.html
http://www.tdbellenterprises.com/blog/2005/09/08/valuation-executives-versus-venture-capitalist-2/trackback/
http://www.infobaseventures.com/valuation-model.html
If you like my posts, please leave comments in here or even better link from your blog so I can get some readers :).
YOur post was very helpful. Gave me an insiders perspective that is usually not visible on standard valuation type articles.
Posted by: Iqbal Ahmed | April 14, 2006 at 05:41 AM