Startup Valuation - Investors' Perspective

An investor is here in the startup world to make money but he definitely knows that he can't have 100% of the Company. If a startup is successful even 1% is more valuable than 100%.

Investors are smart people and they generally have lot of experience in investing. In the back of their mind, they always do backward working for the subsequent rounds of investment. For example, A Series A investor will leave the space for Series B, C, and so on and he will also think that the founders should not be pushed to a level where they loose interest.

Dilution Stages

A seed investor generally takes not more than 10-15%, A Pre-Series A or Series A investor will take 15-20% and Series B can take another 15-20% of the Company. If we calculate the total dilution, its 40-55% till now, leaving 45-60% with the founders but in most of these cases, Series B generally buys out seed/ angel investors, so the net dilution comes back to 30-40%, keeping 60-70% with the founders. However, the dilution may vary significantly depending upon the circumstances, rounds and the quantum of money being raised. Flipkart is the best example which raised multiple rounds at diversified valuations, even in the same years.

Valuation Methods

Needless to mention, all investors specially institutional investors do their Market Analysis and back their workings using various valuation methods involving Market Multiples, DCF and Berkus Method, among others. Market Multiples (Precedent and Trading) are used when the similar kind of companies are already traded or have recently been funded. DCF is a company specific method of calculating the valuation based on its future projections but these are "Excel Workings". I have intentionally used the words "Excel Workings" because it can give you any desired valuation - Still this is considered as important method if used rationally. It can help founders do their own homework as to what level they can achieve or take the company, calculate the funding requirements, helps in the proper planning and finally helps in the projections vs actual analysis (post investment).

Common Mistakes

One of a very common mistake, which we have seen - people tend to do such an aggressive projection which is even beyond market size. One should be very careful here!

Another common mistake, which I heard from lot of investors is - "Over Estimation of Execution Capabilities". Execution is dependent upon people and, founders need team, they can't do everything by themselves and here comes the problem - Hiring takes time and then it also takes time for new hires to settle down and there will be failures as well. Thus, founders should be very careful in projecting the targets as execution could be tough.

One should never think that money can buy everything. Even the sufficiently funded startups are facing the execution risk. I have seen SWOT Analysis in many pitch decks saying Money/ Funding is the only weakness. However, that's not true!

We have noticed in many companies going for Series B, C rounds of funding - whenever they are asked about the projections achieved with previous round, they are unable to answer. Thus, I repeat, One should be very careful and reasonable in drawing the projections.

Conclusion

At the end, I would say that Investors are intelligent people and they know they will only make money if the founders are successful. I have not seen major fights in the valuations if the startup is good, well prepared and and knows what they are talking!

Please share your experience, feedback and comments