Early-Stage Startup Valuation: Fundamentals & Methods

Deciding on a startup’s valuation is a key element in making an investment deal. Premature companies have very little to go on as to definitive metrics to gauge their value. So it’s often a challenge for both founders and investors to come up with a sum and agree on it.

Why is it so important to get it right? Well, the startup’s value also determines the price of equity an investor receives in return for their capital infusion. If the valuation is too high, it might not make sense for them to contribute as their returns will not justify the investment.

Founders must find common ground with their investors and make the valuation seem reasonable for both sides. In order to do that, they need to understand the fundamentals of startup valuation.

Pre-money vs post-money valuation: what are they?

Whenever there’s a conversation about valuations, you are bound to hear terms like pre-money and post-money. Just as the names suggest, pre-money valuation is how much a company is worth before investment and post-money valuation is its value after a round of fundraising.

The pre-money valuation is the one usually negotiated with investors as it determines how much capital the investor needs to infuse to get their desired amount of equity. It’s no rocket science but let’s break this down with an example:

For instance, say a founder and investor agree the company is worth $1.5 million prior to funding and the founder is asking for a $500,000 investment.

This means the pre-money valuation is $1.5 million, whereas the post-money valuation is:

Post-money = pre-money + investment = $1.5 million + $0.5 million = $2 million.

Then, the equity percentage owned by the investor will be:

Equity = investment / post-money = $0.5 million / $2 million = 25%.

Most VC investors will be looking for 20% - 30% of equity to justify their investment. If the valuation gives them any less, they might want to bring it down or secure themselves with predatory investment deal terms. Founders need to anticipate this and provide a fair deal for all.

Startup funding stages: understanding where you are

Go Global World harbors a strong relationship hub for startup founders and investors. One of our pitch programs is dedicated to getting founders fully prepared for pitch sessions with international investors. Quite often we see founders who have a vague idea of where they are in terms of their startup’s evolution and what they need to get to a particular funding stage.

This is very important as a company’s maturity determines how much capital a founder can expect from a potential investor, the types of investors interested in contributing to the startup, and the valuation range as well. Let’s take a closer look at what one needs to accomplish to qualify for the various stages in startup evolution.

Idea or bootstrapping stage: from product development to early sales

Sometimes founders overestimate and think of themselves as pre-seed or even seed companies when they are still in the idea stage. Unfortunately, if you still have no product, customers, or significant sales to show for, then this is where you are.

The bootstrapping stage basically means the company is more or less of just an idea (on paper or sometimes even a napkin). You are in the idea stage if you are still working on:

• Building the core of your team (essential roles)
• Working on the first prototype or MVP
• Shaping your product based on customer insights.

Latter-stage idea startups closing in on the seed stage may even get to generating revenues, but most of the time, the money made goes entirely into further product and brand development.

Traditionally it is thought that the idea stage means you have to depend mostly on yourself and only get funding from friends and family aka FFF funding. But the business climate is getting warmer year by year. So now we have funds that actually invest in your vision, and not in products or traction.

Funds like RallyCry and Ann Arbor Spark aim specifically at idea-stage startups. Capboard, an equity management provider, lists a directory of investors that fund an idea or patent-stage companies.

When a company can only be judged based on an idea or vision, founders can expect a check of up to a few hundred thousand dollars, and be valued from $1 million to $5 million max based on how well you pitch. Your reputation helps a lot in this case, and founders with more pedigree are bound to have a more valued company.

Pre-seed stage: from MVP to product-market fit

At the pre-seed stage, you are still conceptualizing and working on your product’s core features and aiming to find your product-market fit. So obviously your customer base is limited at this point.

The tell-tale requisites of a pre-seed startup are:

• Viable idea, vision, and set goals
• Qualified and experienced team
• Minimum viable product that actually works and sells
• Early signs of traction and revenue growth.

At pre-seed, you have a little more room and opportunity to land an investment. This is when you can finally head to Y-Combinator to present your startup and use the incubator setup to nurture and grow your company. It’s also prime time to start applying for Go Global World’s Demo Days pitch program and GGW Sharks events.

Pre-seed is still an early stage for a company and investors are often reluctant to take chances on an idea without a proven track record or a strong customer base. Founders Go Here have a good list of VC funds that frequently invest in pre-seed startups.

In the first quarter of 2023, the valuation range for pre-seed startups according to AngelList’s report was from $6 million to $12.5 million.

Seed stage: product-market fit, real traction, and growth

The seed stage means you’ve charted beyond the MVP phase and created a product that sells with the early metrics to prove it. You may be still putting some final touches to it, but for the most part, you have a product that is in demand by your customer base.

To qualify for a seed-stage investment you need to have:

• Proven product-market fit with the target audience
• Fully established team with experts in key areas
• Clear signs of traction leading to increased sales
• Increasing growth in customers and revenue
• Positive customer acquisition vs lifetime value
• Enough revenue to support your operations.

Venture capitalists are more willing to engage with seed startups. This is where you start to get attention from big names in the investor space like Andreessen Horowitz and Greylock.

What can you expect in terms of valuation? Well, for the first quarter of 2023, the startup scene had seed valuations ranging from $12 million to $25 million.

Series A and beyond: from revenue to profits and expansion

When aiming for a Series A level investment you are closer to an established brand with a product that’s in demand and has loyal customers bringing you a significant monthly revenue. Showing the potential to scale at least 10x your current value is a great sign for investors since that’s the size of return the major venture capital firms expect.

Series A is strictly for the major leagues: venture capital firms and super angels. You are now able to source financing from top investors around the world.

Greater opportunity also means higher expectations. Not only do you need to meet Series A requirements, this is where your company will be diligenced and examined from head to toe: be prepared to show great financial metrics, exceptional management, and high growth potential.

AngelList’s report showed valuations for Series A in the first quarter of 2023 range from $40 million to $90 million. Going beyond Series A, you are expected to demonstrate serious growth, expansion, and product development. That’s when a startup becomes an established brand and is valued as such based on achievements and financial metrics.

Key factors for valuing early-stage startup companies

Founders need something to back the valuation they are suggesting. Investors have to look for signs of maturity in a startup.

The formula to catch investors' attention: ...

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