How to value your early stage venture to secure co-founders (part2)

Valuing a new venture is one of the more challenging areas in building that new venture. How does a founder set the right price? Neither too high, nor too low? Perhaps I can add some clarity.

And because that article became too big for one post, I'm had to break this article into 5 pieces. The original post started getting bigger & bigger (it's such a big question), so I broke that down into 4 additional parts over 4 more posts.

Following on from yesterday's article "How to value your early stage venture for all investors (Part 1)".

Which is such a tough question.

In this series of 5 posts, we'll start by breaking down the different stages of investors, and how to attract each of them.

Over each of the posts, we'll look at:

1. How to value your early stage startup venture for all investors (Part 1)
2. How to value your early stage venture to secure co-founders.
3. How to value your early stage venture to secure mentors & advisors.
4. How to value your early stage venture to Attract Investors.
5. How to value your early stage venture to secure Investors.

Let's pick up the threads from the last post.

The founder, 'you,' is the first investor. But so are co-founders.

Before talking about how to attract cofounders as investors, let's have a look at what you’ve got to offer them. Remember in the previous article where I talked about "think about the end-game and then reverse engineer back from that"?

And you may not need a co-founder, but you are going to be building a team of people over the next few years, in order to succeed. Knowing what you have to offer, for each type of investor, is key to inspiring them to help you create your great success story.

So before we talk about the how, lets have a look at the Why & What.

So what would be a reasonable return for which type of investor?

Here's what a good table of return on investment looks like for risk & reward, for each type of investor group, when we are talking about higher risks.

Why such a small return for VC's? Don’t they want 100X?

Remember, we aren't talking about a 'Unicorn' style $1B company, which is often what typical VC firms are looking for. We are looking at a 'zebra' or 'gazelle' in the $50m range of exit.

It's also worth noting that investors that are risking their capital, are doing so across a portfolio. So whilst it's true that they are looking for ventures that can return 100x, not all of their investments will achieve that.

However, in this example, you are the 'jockey', and you can only ride one horse at a time, so you get paid (a little) to ride the horse, and get a little of the 'purse' if you come first (or a place).

But for investor, they only get paid the big bucks if one (or more) of their horse wins outright (their success fee), so they have to achieve their returns across a 'spread' (a bit like backing more that than one horse in a horse race) of horse, jockeys & races.

The vast bulk of the successes in their portfolios will only give them a 3-7X return, and it’s only the 1-in-20 or so in their portfolio, that becomes the 100X. That's why the rule of 72 applies to them (but not you), to get paid; they need to double their portfolio value in 5 years, and then double it again the next 5 years, in order to get paid.

(Sure, they do make a little on 'training fees' - but that’s just to keep the stable doors open)

• Which is about a +14% annual compound growth rate across their portfolio - starting to see why VC's rarely invest?

However, if you can figure out how to get VC's a 5X return on their money on an exit valuation of $50m, perhaps, and with their knowledge, skills and networks, they can help you figure out how to up that 5X by a factor of 20, to the magical $1B, (or 100x for them).

Better to figure out what good looks like, and then aspire to great, than to imagine greatness but never start on that journey.

I'm not saying you, or any of your investor types should exit at the $50m mark, but the fair thing to do is give each of them the choice.

If they each then choose to want to continue on, that's fair, isn't it?

For me, I like the model of FOOT

The means, Fair, Open, (h)Onest, and Transparent. (ok, I had to hack that a little to make it fit, but I'm sure you can forgive me).

In this world of scarcity where, many may try to take advantage of you for their own benefit, or what I call a 'Scarcity mentality', I've come to recognise that a significant proportion of the population are cottoning on to the opposite way of thinking. I call this the 'Abundance' model, where in order for me to have more, you must also have more.

Or simply put, instead of "Slicing up the pie, and fighting our piece of it, why don’t we together simply make the pie bigger and bake more pies?". That way, we all get a larger piece.

But that requires everyone to buy into that. Some time ago, I discovered a framework by Mike Moyer called Slicing Pie, which helps you to figure out what your slice is worth at a 'pre-liquidity' level - that is, before you get your first 'big money' in.

And I recently wrote more about this in a blog post, "Why 50/50 rarely works for founder equity splitting".

So rather than re-invent the wheel, what I suggest is that you take a look at how that frame plays in terms of incentivising co-founders, and also its part in eliminating many of the causes of co-founder conflict in early stage ventures, chief amongst them is the splitting of equity where there is a mis-match of workloads and contributions.

And it not only meets my FOOT framework, but it also certainly solves the challenges of valuing a venture at the very early stages, both for founders, mentors and very early investors, as well as going a long way to eliminating co-founder conflict, at least over equity slices. I encourage you to read his book.

Actually, if you buy into the principles outlined in Mike's book (above), its actually quite a lot easier. Mainly because it's based also on abundance.

If you’ve read any of my other articles, you'll likely have read my saying "think about the end game & reverse engineer back". That’s not so easy in practice, unless you’ve done it a few times.

In the next article, we'll see how the above method leads on to bringing the next level of investors, - "Mentors & Advisors".

"To Your Success", Daniel

PS. I've set myself a big bold challenge (have you?) - this is the 5th of 60 articles in 60 days. If you aren't following, commenting, sharing, subscribing, liking (or hating) any of my other articles, then what on God's earth are you doing reading this post? ;-)

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About Daniel

I'm a founder, mentor, advisor, investor, venture catalyst, accelerator, and venture capitalist. Also traveling under the alias of 'That Startup Guy', I am a co-founder of StartUp Foundation (The Startup Accelerator for Experienced Professionals) and am intensely, deeply, passionately dedicated to "The intersection between personal mastery & business entrepreneurship".

My goal is to help you, by guiding you through the steps, and past the challenges and pitfalls, to turn that 'Great Idea' into reality, whether it's a business, service, product, or to disrupt an entire market.

And if you've got an experience about startup success (or failure), comment about it. If you've got a question, reach out to me via your preferred social media. Other posts can be found here on Linkedin.