Seed Stage Valuation Guide
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.
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.
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.
12-18 months ago: $2M-$4M premoney
Today: $2.5-6M premoney
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.