Seed Stage Valuation Guide

Posted on January 12, 2011. Filed under: startups, venture capital |

I find it strange that with all the VC and Angel blogs out there, nobody seems to explicitly talk about the single most interesting term in startup financing: Valuation.  Look no further than Chris Dixon’s blog for elucidation on such nuanced terms as founder vesting, convertible notes with caps, etc…but where do you go to find out how much you should expect to give up at various stages in your company’s development.  In the past week alone, I’ve regrettably passed on more than one deal because the valuation the founder was seeking was an order of magnitude off from what was appropriate, and frankly I am pissed.  I am pissed that the earliest “committers” to these rounds aren’t advising founders that they are pricing their rounds incorrectly.  Notice I am not saying I am pissed that the early committers aren’t doing a better job of negotiating.  It’s not about negotiation, it’s about pricing a round in a way that does not lead to adverse selection when a founder goes out to fill the rest of their round.

By definition, the investors with the best deal flow will have a higher bar on what they do and do not invest in, and will be less likely to pay 2x the appropriate valuation for a deal when there are 3 others they are looking at concurrently that are better bets from a risk reward standpoint.  Conversely, the “me too”, “here today, gone tomorrow” early stage investor who is clamoring to get into a deal with the big name angel who committed early and independent of valuation will gladly pay up to play, but is that really the best move for a founder?  Probably not.  The reason that I’m not willing to overpay for an inflated seed round has nothing to do with returns for our fund.  It’s not a math problem I’m trying to solve where I say at $3M premoney we’re going to make a lot of money, and at $5M premoney we’re not.  Rather, I view a founder’s attempt at closing on their first round of financing at an out of whack valuation as a warning sign of a more fundamentally dangerous datapoint: bad judgment.  Whether I bet at $3 or $5 doesn’t matter all that much, but whether I am betting on CEOs with good judgment vs bad is an extremely good predictor of our fund’s overall success.  If you are raising your first round of capital, you should be pricing your round at the valuation where the absolute best investors in the market will all be excited and willing to participate, not at the maximum price where you can find some investors to participate.  If you’re not sure what these numbers are, I thought I’d explicitly articulate some signposts.  This is by no means absolute, and the market changes month to month, but here’s how I’d be thinking about it by stage of development and setup:

DISCLAIMER: this may vary by geography and past experience of founding team.  I write this more to begin a public dialog and less to personally define the market.  I welcome and encourage other investors to and entrepreneurs to explicitly publish what they’re seeing and feel is appropriate.

Still at your old job

You have an idea you’ve been thinking about, been working on it nights and weekends and maybe you’ve pulled together some folks to help you work on it.  You may have a prototype, you may not.  Everyone is ready to quit their jobs, you just need funding and then everyone is on board.

Valuation range: Don’t bother.  There is no market for your deal.  Nobody, not even friends and family should give you capital and you shouldn’t ask for it.  If you’re not committed enough to take the plunge without financing in place, then you’re not committed enough to ask for investment.  Quit your job.

Pre-product

You have an idea, and you’ve done a bunch of diligence but you haven’t begun to build anything.  Maybe you have some wireframes or designs, maybe you don’t.  Your idea is great and you’re chasing a big market.  You might even have domain expertise in the space.

Valuation range

12-18 months ago: $0 (no market for your deal, only friends and family capital available) – $2M pre-money (you have a personal brand having either started and successfully exited something or been very early at a startup love story)

Valuation range today: $0 (no market for your deal, only friends and family capital available) – $7M pre-money

Appropriate: This deal should only be getting done with a founder who has a proven track record, and in that case $2-3.5M is the appropriate range.  Everyone without a track record should be building prototypes and collecting data to validate their thesis and derisk  the deal by showing an ability to execute.

Average Size of deal: $300K-$700K

Protototype Built and in the market

You’ve assembled a team that is capable of getting something tangible done.  You’ve flushed out your vision and taken a first hack at realizing it through product.  You’ve gotten deep enough into the weeds that you’ve already identified the first set of assumptions you made that were wrong, and might even have some early data that says a few assumptions were right (i.e. user feedback, early signs of growth, market praise, etc.).  If you can make it here bootstrapped, this is I believe the optimal and appropriate time to raise a seed round.

Valuation:

12-18 months ago: $2M-$4M premoney

Today: $2.5-6M premoney

Appropriate: $3-4M

Size: $400-$1 million

Product in market and signs of growth or revenue

You pushed your product live 2-5 months ago.  Users are using it and either spreading it or paying for it.  You’ve build a team that is executing well and you are raising money to add resources that will support growth/expansion.  Not quite at the point where you have a sick viral coefficient or hockey stick curve, but you’re on the verge of product/market fit.  Questions are more about how big is the market and less about validating the earliest assumptions.  This is really an A round, and you shouldn’t be calling it a seed round even if you haven’t taken previous capital.

Valuation: hmmm. Ask Fred Wilson, Bijan Sabet, Mark Suster, Roger Ehrenberg, and anyone else with bigger funds who are blogging about bubbles and valuations to publish their signposts.  They’ll have a better sense than me.

Size: $1-5 Million

I think as investors we need to get transparent and explicit about what we think is appropriate and what we want to see from founders.  There will always be exceptions, and obviously the guy who founded Mint is going to get a different deal than the guy who just quit his job in consulting, but I don’t really understand why we aren’t publishing what we want to see change in the market.

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67 Responses to “Seed Stage Valuation Guide”

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para 2,
2 x weather = whether

thanks tom. spelling isn’t my strong suit

Jordan: I have absorbed an absurd volume of posts and essays within the start-up/VC/entrepreneur blog ecosystem over the past 12-18 months, and this is one of the Top 3 most valuable I have read. Thank you. I hope this sparks a larger discussion of this and creates even more transparency. But just on its own, incredibly helpful.

Awesome, glad it was helpful…

This is great Jordan!

Thanks for taking the time to write…very helpful!

Paragraph: “Still at your old job”, last sentence: “not” –> “need”

One of the best posts about raising $$$ on the internet.

btw. I think you need to write a post defending your assertion that good investors are worth the (sometimes 50%) hair cut in valuation.

Are the best investors really worth? 100% more? 50%? what about good investors?

For example, you say that pre product deals are being done for $2-7M, but $2-3.5M is the “appropriate” range that will attract the best investors. Meaning that it would be the right decision for an entrepreneur to sell his company for half as much to one investor over another. I’d love to see you flush out that value prop (and not the BS that is written on ever VC website- wat else besides thought, connections, and signaling to later investors?)

I will do this when i have time…

Jordan, thanks for taking the time to write this. You might want to disclaim that these are for XYZ types of companies such as consumer Internet as valuations across the board might be up, but within b2b, consumer, ad tech, etc – are all a bit different

Fantastic post. As an entrepreneur looking to raise early-stage finance, this is just so helpful.

Not that your valuation ranges are so far off from what I’ve heard or guessed, but it’s refreshing to have it stated in such a transparent and explicit way.

I imagine investors will find it useful too. Well, maybe not the bad ones.

This resonates pretty exactly with what I’ve been seeing in Silicon Valley. There is a premium for certain types of companies (particularly YC) but more or less, this is what the smarter of my entrepreneur peers have been looking at. Great for making it public.

Interesting Piece – One of my initial reactions was similar to @Darren, believe specifics around domain expertise and operating space is valuable here.

It also occurs to me early-stage/seed ventures are beginning to enjoy a period of ‘Modest-Exuberance.’ Some is fueled by CEO and Venture Teams keying off comments from the blogosphere/ecosystem drawing attention to a flat equity market, jittery bond market and weak IPO market.

The rest seems to be driven by the changing technicals of the early-stage funding market. Every day I find newly organized pools of capital, syndicates, or venture funds increasing supply and in turn putting upward pressure on price-expectations/valuations. The number of deals worthy of funding is growing much slower than the amount of capital allocated for funding.

I would also, enjoy reading a blog on evaluating Deal Valuation and funding strategy relative to judgment. Think Founders ought to optimize total amount committed against the qualitative aspects of an investor or group. Comes back to the old adage – no such thing as bad risk just bad prices – true for both capital and founders.

So, I’ve got a product, it’s in the market for 3 months. Has gone from Alexa # to #860K globally and #300K US – and makes a few dollars a day revenue.

You’re saying I should value this product at between $2 and $6 million?

Awesome… Where do I find a buyer?

Jordan, awesome post. Added this to our StartupDigest Reading List today.

Your right in that nobody talks about valuation and even if this isn’t perfect, it at least gives founders some where to start negotiating.

[...] finding the question of valuation a bit daunting. Helpfully, Jordan Cooper just posted a seed stage valuation guide which helps answer some of the [...]

This is one of the clearest articles about the topic of valuation that I’ve read so far. I was wracking my brain over this topic and trying to understand it since I am in pre-launch stages; this makes much simpler to understand.

Excellent post and certainly has sparked a conversation. Wanted to get your take on a scenario were founders have launched and gained some traction but not able to quit day jobs at present run rate and need additional capital to grow the biz. Does that still fall under “do not bother”?

I’m afraid the answer is yes…

To say just because someone hasn’t quit their job means they are not dedicated enough is ridiculous. I for couldn’t afford to quit my job if I didn’t already have financing. I’d be on the street within a month, car repossessed, and starving.

that’s ok travis. it just means you might have to self-fund until you get to a different spot

in other words….just let the vc’s decide what your venture is worth or the value thereof. I love these types of articles as they remind me of the story about the fence turtle. blah blah blah, we love your deal but the valuations are to high….here’s our offer, you pay us (vc’s) $5.00 bucks and we’ll take this dog off your hands. Or ….you want to sell your car, ok I acquired one just like it last week, the owner had to pay me $100.00 to tow it away. All in all you wrote a good article. The problem as I see it in the venture world is monkey see monkey do. There is no right or wrong, each deal needs to be valued on it’s on merits. You’re almost trying to lump them all into one category. I can see someone building an app for the iphone where the above statements ring partially true. What about a venture that’s going to take $20mm and has the potential to make hundreds of millions? I wish I had another hour to finish this but I need to get back to my “venture”, it needs me. hugs and kisses

well…i couldn’t write a post that accounted for every individual company…you’re right, each deal needs to be evaluated independently, I just wanted to provide some ranges.

Young entrepreneurs, don’t be fooled by people who try to apply overlays of “truth” on markets, or on top of life in general. These are the sentiments of a single emotional investor who is “pissed off”. And that’s okay. Take the $30 million pre valuation and get on with it. Sometimes you’re going to piss people off. That’s life.

That’s terrible advice.

You’re right. Don’t take money from flippers at $30. Be the next Google ant take money at $70 or even better don’t take their money at all.

That’s fine if you are Google, but they were an extremely rare case.

Being a dreamer on early stage valuations will get you tarred pretty quickly in the industry as someone that is unable to accept reality and who certainly won’t accept or act upon advice.

Take the money at a lower valuation and have a smaller share of something that is funded and moving, rather than a dream and forever stagnant.

Refreshing post, especially as it addresses the recent valuation “correction” of the past year. One question: Why is the upper limit $7MM for “Pre-product”, yet only $6MM for “Prototype built and in the market”? Am I missing something?

Thanks for getting the ball rolling on this topic; along with the actual raise, this is typically the main concern of founders.

[...] Pretty good guide on realistic startup seed stage expectations. [...]

I am amazed at a valuation of 1 million or more for something that is not validated concept. I have a product, users , a demographic, sales, and a major hardware company wanting a partnership, yet i can’t get time of day from an investor even if i begged. It has turned out to be a good thing as I have not diluted and still have complete control. This blows me away: “You have an idea, and you’ve done a bunch of diligence but you haven’t begun to build anything.”

Brilliant, invaluable advice for novices

Cheers Jordan…when converted to £s, this is scarily close to what we’ve been thinking internally – and gives me some broader shoulders for the 2 angel meets I have tomorrow. Excellent!

While I do think these are good reference points for a lot of newbies, I find a lot of serious flaws here that should make any entrepreneurs question the value of this advice:

First, while its important to understand what your valuation is, its important to keep in mind the source of your information. This is an investor is “pissed off” that they couldn’t buy a piece of a company for cheaper. At the end of the day, he has every incentive for you to undervalue your company.

Second, you can’t make these kinds of generalizations without considering a lot more than just the life-phase of the company. Things like competitors, barriers to entry, signed bizdev contracts, potential market size, etc all come into play. This seems to be fairly narrowly focused on a specific set of web product plays.

re: source of information, I am in investor, but I’m also an active founder and CEO, and am in this financing market as an entrepreneur just like you and everyone else…I would and have abided by my own advice

re: competitors, barriers to entry, bizdev, etc…all these come into red light green light decision at this stage, but the truth is we rarely have meaningful datapoints around these variables at the earliest stages where I am generalizing.

Great post Jordan! A post like this can save an entrepreneur months of shooting in the dark and trial and error. While starting a company in Utah i’ve noticed how true your disclaimer can be. There are some killer ideas and companies out here but because of the overall lack of capital many deals close at 1/3 the valuation of similar deals in the Valley. It’s tough for a lot of them to get off the ground and get momentum cuz they either don’t get enough money and are doomed from the start, or give up so much of their company that there’s not enough left for later rounds to continue growth. It’s just a side effect of the market but if these new companies aren’t getting enough money to succeed investors are going to lose their money anyways.

Interesting. I think in general these guidelines make sense, but it is also dependent on the business fundamentals of the idea. One of the reasons Groupon and the likes are great businesses is that the cash flow fundamentals are great and you are dealing directly with consumer purchase behavior.

Shouldn’t valuation be based on the (potential) economics * the risk of execution?

potential economics largely influence the decision to invest or not invest for me. If i can’t see a path to $1 Billion company, independent of the difficulty in getting there, i’ll tend to sit out

Hi Jordan,

Just read your post on startup valuations and had a couple of question. From what I understood, the deal for $400k in seed capital for a Protototype Built and in the market company should be roughly 12% at $3.4M post-money. What if you are only raising $250K in your seed round, does that change the pre-money? What would a sophisticated investor need to see in real cash returns, say in 3-5 years to make them want to invest ?

Jordan

This post is really awesome. I’ve read so much around this topic in the last 18 months and this has probably been the most clear and useful.

Thank you!

Jordan, from a fundamental POV, today’s startups (that work) are more scalable and profitable than previous generations. I’d love to see the stats on how many are getting past Series A – my sense is that win ratio is improving in certain areas. So, if you apply ExpectedValue = Probability x Expected Outcome, there are actually very strong reasons for high-quality deals to have much higher pricing than your guidelines. It will likely stay that way until counter-evidence pushes those factors down.

All interesting thoughts. The one that stood out to me is the point on jobs – I understand the logic here, but taking the plunge (quitting your job) is a big step if you have no savings and no funding guarantee. I mean. one has to eat. Nevertheless, I wonder if there are any resources or advice for those in a similar position. I’m fortunate enough to be an MBA student with time on my hands, but just curious here

Great thoughts, Jordan. Thanks for taking the time to write them up. I’ve re-read your post at least 5 times and spent the last 30 mins thinking about it. You cover a lot of good ground here.

Most amazing to me is our sense of perspective. Relative to the whole world of finance, these numbers are just so small that nobody really cares. $2M? $5M <>

People make decisions for different reasons at (relatively) small numbers. To take an extreme example, the lottery is among the worst ‘investments’ you can make, yet people buy tickets in droves. They just get other value out of the activity, and the social proof from investing in (or raising money from) high-profile investors is worth the tradeoff for many.

I don’t see a good reason to believe why we’ll ever see any rationality or consistency to seed-stage valuations ever again. Rationality would dictate something along the lines of “I’ll pay you a relative to what your making now for a chance at the upside”.

Would most entrepreneurs take a lower valuation to raise money from Dave McClure, Fred Wilson, or Mark Suster? Of course. Is there evidence that the tradeoff is worth it? I don’t know.

Great post.

First of all, thank you for writing this post as it provides some great insights from the other side of the investment world. I have had my own experiences with early investors and I am very jaded on obtaining money before its time.
That stated, my current dilemma is one concerning when to go to market. My product is complete and, short of some final signing procedures, ready to go out to market. At this point I am utilizing an international network of about 11,000 proxies and in a few months that number will grow to over 15M. This is not due to searching and finding new servers, rather a new iteration in development needs to occur and that will take 2-4 months.
Currently the user experience is OK but, given the endpoints being used, nowhere near the experience that will be obtained 2-4 months from now. I need to raise money now as I can no longer fiance things out of pocket and thus I am faced with the question of going to market now with a product that may or may not meet expectations or to try to raise money upfront and build the next level.
I know Lean Startup principles say “why are you not already out there?” but I also think you get one shot at current consumers and then you are done…what advice would you give?

No single number can fit every situation.

A seed round occurs when entrepreneurs need to remove some uncertainty about the likelihood of success of their venture, reduce the information asymmetry with investors and lower their future cost of capital. Statistically valuations for seed rounds tend to be 50% to 70% lower than for series A, which gives a hint of the value created through seed capital.

From the perspective of the investor, the tradeoff is between investing in the seed round and getting a higher return if the venture is successful in reaching series A, or investing in series A directly and skipping the early risk. If we assume a return of 100% (discount of 50%) on successful seed investments to series A and a probability of going to series A of 60%, the investor gets a return of 20% on his seed portfolio. From the investor’s point of view, maximizing the probability of success of his seed investments is prioritized over getting a lower seed valuation, which is likely to impact future valuations and dilution anyway.

From the entrepreneur’s perspective, the seed deal will lower the future cost of capital by reducing uncertainty. This results in an increased valuation later down the road. The question is what amount of dilution is an entrepreneur willing to incur in order to cut his cost of capital by half, for example. It becomes a capital budgeting problem where you attempt not only to maximize the current valuation but future valuations as well, weighted by the amount of capital you need to raise at each round. The seed round is obviously the one that weights the least in the balance, and therefore the seed round valuation is not as important for the entrepreneur as much as by how much the valuation will be increased for the next round. Assuming once again an increase of valuation by 100% from seed round to series A, the entrepreneur could be willing to take a 40% dilution and still get at 20% return from his side of the deal by lowering his cost of capital.

A fair deal would make the returns from both sides of the deal as close as possible one with the other. A rule of thumb is that an investor should get a share of the venture roughly equal to the probability of its failure, while the entrepreneur should keep a share equal to the probability of its success. The resulting valuation is simply a matter of size of the investment, and has nothing to do with how much the opportunity is estimated to be worth.

Was that you, Eric Ries?

The preceding comment was as enlightening for me as Jordan’s cathartic valuation post. I agree that focusing on fair deals, rather than valuation, makes for a happier world. New rounds can be raised quickly for hot companies.

Entrepreneurs tend to be a confident lot; investors even more so. Apportioning the share/risk “rule of thumb” that Eric cited will always be a cause of high blood pressure and sleepless nights during negotiations.

Since you both see deals from either side of the table, what advice would you offer for gauging—as fair as possible—the likelihood of success or failure of any particular venture? Perhaps there are conditions and indicators that correspond to Jordan’s stages above, such as the previously successful founder example.

I’ll volunteer to graph the findings!

Thank you, both, for the perspective.

I have taken the leap. I have quit my job, but my colleagues are highly paid rock star dev people so they haven’t quit. The site is already Alexa top 7000 and has the potential to change the world. It’s achieving huge traction. The product is in market and growing fast in terms of users and revenue with our freemium model. Not quite hockey stick, but not far off. Our website is in the multi billion cloud storage sector. Any advice? Suppose I should get an intro to meet you :)

Thanks for exclamation mark! We’re really excited. I need to talk with the other guys as we haven’t even talked about funding. I’m trying to learn how it all works. It’s a different world to building a site. Your post was awesome, and your firm seems superb. They say you can only make a first impression once, within the next month we’ll be adding some game changing features. Should I send you the link then?

Jordan, thanks for recognizing and making transparent the pink elephant “insiders” are sworn to secrecy on for no good reason. Your guideposts have given me more useful information in 4 short paragraphs than what I’ve read in the last 6 months on numerous blogs combined.

Jordan, thanks for taking on a difficult subject. Great post. Here’s another informative one by Nathan Beckford: http://www.seedstagecapital.com/2010/01/startup-valuation-how-much-is-your.html

I suppose you might not be watching this post anymore, but what if you can get to “Protototype Built and in the market” while keeping your day jobs? Granted we are talking about a small number of early users (think 25 or so, B2B, some users independent contractors), but I should think it should be doable? In this scenario it wouldn’t be waiting for investment to quit jobs, but would maybe involve quitting right before going to raise.

How would you recommend coming up with a valuation in that instance?

[...] guide which is the best document on the level that I’ve seen. Just Google Jordan Cooper Seed Stage Valuation Guide. Basically, what he says is that. Market is anywhere from a one to five, pre-money, one to five [...]

Jordan,

How perfect is this to stumble upon on a Sunday morning. Very helpful, and timely as we are in “Product built and in market with signs of growth and revenue”. An excellent validation of our work and provides some good benchmarks and company stages to identify with.

Excellent post. Thanks.

Entrepreneur with a 21 year track record of success, but never in the hot seat until today.

Strong Post for a bottom up valuation, Sun Light.

This is valuable insight Jordan, thank you

Hugely valuable. More founders need to see this.

Jordan, thank you for the blog post, however there is part I do not understand technically and conceptually from a valuation standpoint.

I am trying to value a prototype sensor and I have the following Chicken and Egg type problem: How do you distinguish at a seed stage between Pre-money and Post money valuation in order to quantify the Equity claim for the VC/Angel, more precisely, what is a non negative Pre-money valuation given that you have 0 or very limited capital?

Indeed in a Pure Seed Stage timeline, future development is almost entirely contingent to seed financing, that means that a valuation without start-up capital (even post R&D which cannot be capitalized) is worth next to nothing. If the financing is used to finance the “R&D –> Market” product phase, the company has ”no value” without the financing and 100% of forecasted (Capex considered) value with it. However that does not mean that a VC investing the marginal x Millions in a company in order to take the product to market will be receiving 100% Equity…

**(eg: I own a Pharma company that has only one drug in pre-license trials, already invested 10 M in it and I need an additional 20M to obtain the license, without these 20M my company is worth nothing as no license means 0 revenues–> 0 CF, with these 20M my company will be worth 10 Bn (it’s the cure for cancer) in market potential post licensing, in a pure incremental analysis the 20M take me from 0 value to 10bn value (all simplification considered), this however cannot mean that I would have to let go to all the equity… how do we calculate the incremental value of the 20M ?)

My question: how do we calculate a suitable Pre-money Valuation given the dependance to Capex provided by the financing round? Maybe I am wrong in my with/without structure… but I’m trying to get an answer to the “corner-in argument” : “without my investment you re worth nothing!”

How do you mathematically defend the 1,2,3, M valuation pre-money?

Thank you in advance,
Tudor

What do you think about a one-man-show ? Is this always a deal breaker ? Even with a product in the market ?

Wow. This has got to be one of the most absurd posts I’ve seen. 30 yr old kid who has one tiny exit is now trying to tell founders to take $2-$4m pre money? You are a total sellout. Your advice is complete nonsense and your read of the current market is terrible. WC is seeing experienced/successful founders get $2m seed rounds pre-product on notes w/ $15m cap. And great VCs are in those rounds. Telling founders to take crummy deals just makes you a complete wannabe. Go do something important before advising others.

You’re an idiot. Look at the date that this post was written

Great article. If things have changed, I vote for an update!

[…] Seed Stage Valuation Guide - Jordan Cooper […]

[…] Seed Stage Valuation Guide - Jordan Cooper […]


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    I’m a NYC based entrepreneur. I think there is one metric that can be used to measure the value of a human life and that’s impact. How did you change things? How many people did you touch? How different is the world because you lived in it and how positive was the change that you affected? (p.s. i don’t use spell check…deal with it) You can email me at Jordan.Cooper@gmail.com

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