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All about: Funding Round Valuation

Written by
Sam Simpson
Last updated
4th March 2024

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Valuation is the cornerstone of the startup world. Whether you are on the founder or funder side of the table, understanding how to determine the worth of a startup is crucial. Even a relatively unsophisticated investor will understand that valuation is a key negotiation point in any investment.

While startup valuation plays a pivotal role in shaping the future of a company, getting to grips with all the pieces of this multi-dimensional puzzle can be hard to figure out. In this post we delve into the science, and the art, of startup valuation, its methods, and why it matters.

Why Valuation Matters

Valuation is not a mere number; it's a compass that guides founders and investors. For founders, it's a crucial benchmark that can impact their equity, control, and the amount they can raise. For investors, it helps them gauge their potential ROI and risk/reward ratio associated with the investment.

Setting your valuation too low is clearly suboptimal - it means that you've given away more of your business than you needed to in order to raise your funding round. This may mean that future rounds are challenging as, at some point in the future, investors may consider that you've diluted too far.

Setting your valuation too high could have a number of negative consequences:

Common Methods for Arriving at a Valuation

Here's a closer look at the commonly used approaches for valuing startups:

Challenges in Valuing Early-Stage Startups

Early-stage startups, especially those that are pre-revenue (or where revenue wouldn’t justify a sensible valuation), face unique challenges in the valuation process. Comparable businesses are hard to find, and income-based methods can be unreliable.

It's also important to note that valuing a startup is inherently subjective and can vary depending on factors such as the industry, growth stage, market conditions, and investor preferences. It is often a negotiation between the startup founders and potential investors.

Engaging the expertise of financial professionals, such as venture capitalists, angel investors, or business valuation experts, can provide valuable insights and guidance in determining a fair and reasonable valuation for a startup in the UK.

When to publicise your valuation

One school of thought is that you should not disclose your PMV in the pitch. Instead, you find an investor willing to be 'lead investor' and negotiate the PMV with them. This then forms the PMV for the rest of the round.

Alternatively, 'guestimate' where your PMV should be - by testing your pitch and PMV with a couple of angels, by looking at similar companies and finding out their PMV etc - and then go to market and see if the valuation resonates.

Sanity checking your valuation and raise

There’s a simple way of checking that your valuation and raise are vaguely sane: to calculate the dilution percentage in the round.

Normal dilution per funding round is 15-20%:

As an aside, if you publish a raise amount for a round but don’t publish a valuation, most investors will assume you are looking to dilute by 20% and do a quick calculation (raise amount x 4) to estimate your likely pre-money valuation.

Oh, Beauhurst also have a fascinating report which details the amount of equity retained by founders at different stages of their growth (Seed vs Venture vs Growth vs Established) - it is worth comparing your expected level of dilution with this report to make sure you aren't giving away too much equity or being unrealistic and aiming to give away too little.

Why is it a problem to dilute too much?

Having over-diluted founders can be a real problem for potential future investors. Why should they care? Because they want to see a motivated founding team. A founder with just 10% of equity in the company is going to be considerably less motivated than if they had 20% or more.

To give a real world example from one of my own investments how this can play out:

  1. The company had a founder with a healthy 60% shareholding for the CEO when I invested.
  2. This diluted significantly over the first couple of VC rounds.
  3. As they negotiate their next round, the new VC would only invest if the founder is ‘recapitalised’.

In short, this means that the founder shareholding is increased (at the detriment of all existing investors) before the VC invests. This leads to double dilution for a single funding round (the first to recapitalise the founder, the second as part of the funding round).


A straightforward approach

If you are pre-seed, pre-revenue and offering SEIS, my personal way of checking a valuation is sain very straightforward:

  1. Start with the average: Look at Beauhurst's 'average' valuation (£1.4m or so currently for pre-seed) as your starting point. Great businesses should be valued higher than this, businesses with unresolved issues, less.

  2. Get your ducks in a row (and make sure they’re polished): It’s important to make sure you've got SEIS/EIS advance assurance, a solid pitch deck, a forecast model showing a clearly considered and sane forecast.

  3. Amend the average valuation: Revise the figure by adding / subtracting a suitable amount for each of the following factors:

As you can imagine, I see a lot of startups and this is the process I mentally go through to test a valuation. It's vaguely related to the scorecard and Berkus Valuation Method for Startups but crucially sets the starting point on a scientific data point - Beauhurst averages.

In short it means a very polished business (still pre-rev/pre-seed) could justify up to £2.6m or so if everything was perfect. A business with challenges and no sizzle might find themselves at £800k. It's rare to see lower than this number.

Varying Valuations

Don't forget, you don't have to use the same valuation for all stakeholders. You may, for example, wish to thank an advisor for work already done or incentivise an active / strategic investor by offering them a certain discount.

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What not to do Part 1: Test your valuation on your top ten potential investors

A surprisingly common mistake. Get your v1 pitch deck and forecast ready, guess at a valuation and hope for the best, starting to work through your potential investors, best first.

Why not? Well, if you've got something wrong in any of your materials, it's rare to get a second opportunity to pitch...your potentially best investors will walk away.

Much better to test your pitch, deck, model and valuation via a less important set of investors first...Incorporate the feedback and then go for the top ten.

What not to do Part 2: Swing for the fences and expect to negotiate?

If your starting point is crazy, then lots of investors will just walk away. To use an analogy, if I'm going to buy a car and I've got a budget of £50k, say. I'll happily look at a car at £55k, on the basis that I'll be able haggle down a bit. If I see a car for £100k, I won't even bother.

If you are a 'normal' pre-seed / pre-revenue startup and not in a crazy-hot part of the market and you openly value yourself at £3m then most investors will just walk on by. They know that your valuation should be ~£1.5m and won't bother trying to negotiate you to where you should be.

What not to do Part 3: The Bonkers Valuation Example

As a bonkers example of what NOT to do, I saw a valuation report once (it was a rebadged Equidam):

  1. Business was pre-revenue. And, to be candid, the business was lacking in any kind of sizzle. Hadn't developed a product yet, so had a shiny (well, even that...) pitch deck and that was it.
  2. ⁠Product would be designed, developed and launched in a year.
  3. ⁠Seeking £70k initial funding.
  4. Forecasted to achieve Year 1 £203m EBIT. Yes, this is bonkers.
  5. They did 3 valuations. Scorecard came up at £1.5m, Checklist method = £1.22m, the VC method = £640m.
  6. ⁠Despite the HUGE range of valuations they did a weighted average (40/40/20) of the three figures (=(1500000x40%)+(1220000x40%)+(641000000x20%)) to come up with a £129m valuation.

How FounderCatalyst Can Help

FounderCatalyst can help you in several ways throughout your funding journey, and offers a set of valuable tools and resources to assist founders and investors in their startup journey:

Startup valuation is a complex but vital process that sets the course for a company's future. Whether you are a founder aiming to attract investment or an investor seeking the next big opportunity, mastering the art of valuation is crucial.

FounderCatalyst's resources and practical guidance can be your compass in navigating the dynamic landscape of startup valuations, ensuring that your decisions are grounded in reason and data.

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