Startup valuation 101

As an angel investor, I get many questions about startup valuation. In the past few weeks, I had several such conversations, and it is surprising how often graduates seem to think their newly-born venture is worth 1.5 or 2 or even 3 million euros (pre-money).

As good as traditional DCF models are to get to a proper Net Present Value, as are comparable transactions, it is often frustrating to try to apply these methodologies to very early stage companies.

My (very) personal answer to the question is certainly more practical than scientific. At the early stage, I think valuation is mostly a negotiation: how much of a company the investor gets for his investment. Which is partly derived from how much do we (the founders and the investors) need/want each other? Here I want to feel like a partner, not a sponsor.

At the very early stage, to me it is mostly about the team. Everything else being equal, I would value more a proven team (either executives who used to work together in a larger company and were successful intrapreneurs who decided to found a startup to fill an underserved need in an industry they know, or co-founders who are already experienced startupers).

Here is my (absolutely non-scientific) method. With an unproven team of (say) 24 year-old smart engineering/business school graduates, I try to evaluate the cost of the time they’ve spent on their venture (fully charged average salary of such graduates) + a small multiplier (as a consideration for the venture). With a proven team, I add another (larger) multiplier on top. In both cases, the multiplier will be higher depending of their « skin in the game »: have they only invested time, or also money? If money, what kind of money? Love money may be a signal: if it comes from a grand-mother, it may not mean that much (many grand-mothers would consider their grand-children the best ever since sliced bread was invented). A mother-in-law would be a better signal. Even better, your former colleagues and university professors.

How to reconcile that kind of loose alchemy with a more traditional financial method? I think it may be about the discount rate you pick for your traditional discounted cash flow valuation method. Will it be (say) 12% (i.e. low risk / high valuation) or (say) 45% (high risk / low valuation)? That’s where one comes back to the negotiation table: founders and investors might (kind of) agree on the estimated future cash flows, therefore most of the negotiation may be on the perceived risk of the venture, and a large part of the risk is about the human element.

And of course there is love. It’s not so different from a mariage. We’re going to have a romantic relationship for many years to come. I’ll leave you all the space you need, and I’ll be there for you. It’s not just about the money. Our common life will be an (ad)venture. We want to like to be together, to talk together, and more. Ethics, too. There is a lot we want to share. There will be bumps on the road. There is a high probability we’ll divorce years from now, and we want to make sure, while we still love each other, that our child will be well taken care of: we need maturity and a good pre-nup (that’s the Shareholders agreement).

It will feel so good. And in five or ten years we’ll have a special drink together, and look back at the journey.

Well, where did that come from? First of May in sunny Paris. Ok, I get out.

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