Valuing Your Startup

It’s an amazing feeling to see $2 million show up in your company’s bank account! Here’s the playbook we used to raise our series A round for SlideRocket: 

1. Build an MVP and get traction
2. Figure out how much money to raise
3. Pitch a ton of investors (including strategic)
4. Solve for % ownership rather than pre-money valuation

Here's the video of the workshop I ran on Valuing Your Startup:

And check out Rocket Pro Forma if you're raising money and want to quickly create investor-ready financial projections (and I’ve posted a ton of other resources for startups there as well).

1. Build an MVP and get traction 

SlideRocket was presentations in the cloud, originally targeted at business users. 

I started the company with two other people and all three of us had income from other businesses. We were building the next generation of my presentation company, so I had customers we were planning to bring over to the new system when it was ready. My partners had months of severance from their last startup.

So we were able to self-finance the idea and prototype stages. We talked about raising money via a convertible note, but decided to wait until we had more traction in order to do a larger round and get better terms.

We had the advantage of starting with product market fit because I already had paying customers, so we focused on building what they wanted. We did a pre-announcement on TechCrunch in March 2008 and started getting signups to our waitlist.

We launched six months later in October, and we raised money in December. So our investors could clearly see how quickly users were adopting our service, and we took much of the guesswork—and risk—out of the equation.

2. Figure out how much money to raise

If you’re in the idea stage then shoot for $25k to $50k from friends and family. Or convince your first big customer to pre-pay. Or save up enough money that you can fund it yourself like we did.

At SlideRocket we had a waitlist of thousands of people, both free and paying users (although no real revenue yet), and customers from my previous company ready to migrate. 

We built out five years of financial projections and decided to raise $2 million based on projected revenue and headcount.

For companies in our position, Sari Azout—partner at Level Ventures and Entrepreneur-in-residence at Rokk3r Labs—recommends budgeting $15k per person per month for 18 months to cover salary, office space, equipment, general costs like servers, and a margin of error. 

So at that rate our $2 million would give us 7.5 people for 18 months, which is more or less what we did with the money. We had two founders at that point and we hired a VP of marketing, a lead developer, a head of QA, an inside sales rep, and a head of business development.

We did, in fact, go through the money in about 18 months.

3. Pitch a ton of investors (including strategic)

Fundraising is a lot like dating, and we had to kiss a lot of frogs (no offense to anyone we met with). The people we talked to fell into two categories: venture capital firms (VCs) and strategic investors. 

Strategic investors are larger companies that invest in startups, and we had one big-time Web services firm who found us via our TechCrunch article. That led to a bunch of productive conversations and they ultimately offered to invest. 

We were meeting with VCs and other potential strategic investors at the same time. Most of these meetings didn’t go anywhere, and sometimes people were interested but we could tell they weren’t the right fit. One VC wanted us to change both our business model and our behavior—which is a lot to ask of a startup!

We got many of our investor introductions through friends and colleagues. We also hired DLA Piper, a law firm with a big Silicon Valley presence, who helped us with our pitch deck and made a few intros through their startup pipeline program. They cut us a deal where they didn’t charge us until we raised money, at which point we cut them a (big) check plus some warrants that they made money on when we were acquired a few years later. 

Sometimes the VCs would introduce us to other potential investors, either because they weren’t interested or because they didn’t want to lead the round. We met amazing people like Tim Draper and Fred Wilson, and we spent a bunch of time on Sand Hill Road.

4. You can solve for % ownership rather than pre-money valuation

When people talk about “valuation” they usually mean pre-money valuation — so how do you know what that is? If you were an established company you could use discounted cash flow — but that’s hard with pre-revenue startups.

The basic fundraising equation is:

Cash Invested + Pre-Money Valuation = Post-Money Valuation

So $2 million of cash invested into a company with a pre-money valuation of $4 million = $6 million post-money valuation.

The shortcut we used was that our VCs wanted to own about 1/3 of our company after the transaction. So that allowed them to solve for the pre-money valuation by dividing cash invested by ownership %.

Cash Invested ÷ Ownership = Post-Money Valuation

So $2M Cash Invested ÷ 1/3 Ownership = $6M Post-Money Valuation. 

Now simply subtract the $2M Cash Invested from the $6M Post-Money Valuation to arrive at a $4M Pre-Money Valuation.

The offer the VCs made us was “2 on 4” — meaning a $2 million cash investment on a $4 million pre-money valuation.

We negotiated “2 on 5”—meaning a $2 million cash investment on a $5 million pre-money valuation, which gave our VC 28.57% ownership (their $2 million cash investment divided by the $7 million post-money valuation). So we saved almost 5% of equity.

We were okay with the VCs taking about 1/3 of the company because it gave us cash in the bank plus the social proof of taking money from a firm everyone recognized. One of their partners with operating experience joined our board of directors and was hugely valuable as we grew.

Getting the Best Deal

You’ll get the best deal when you have multiple offers on the table at the same time. We had two VC term sheets in hand plus a $1 million offer from the strategic investor. 

Everyone wanted a board seat, so we had to decide between a three-person board (one of us, one investor, and one independent) vs. a five-person board (two of us, two investors, and one independent). 

Having three options put us in a great position to negotiate. After some back and forth we ultimately decided to go with a single VC because we were concerned that the strategic investors might restrict our freedom by steering us away from working with their competitors.

Watch Your Exit Price

Also remember to keep an eye on your potential exit price. Your series A investors are looking to get at least 10x their money within 5 to 7 years. That means they’ll want you to sell your company that’s currently worth $7 million post-money for $70 million.

And if your company has a $20 million post-money valuation then you’ll need to sell it for closer to $200 million.

Crunchbase reports that the average acquisition price for startups since 2007 is $155.5 million, so it gets harder to find buyers the further you go beyond that. There are many more companies who can acquire you for $50 million vs. $500 million, so it doesn’t necessarily help you to raise more money.

Keep in mind that Michael Arrington reportedly made more money selling TechCrunch for $30 million than Arianna Huffington did selling Huffington Post for $315 million—because he had raised less money so he still owned 80% of his company.

Mike Lingle is obsessed with helping founders grow their businesses. I'm a serial entrepreneur, mentor, and executive in residence at Babson College. Check out my Rocket Pro Forma if you want to quickly create your financial projections.