Second blog in a series by Lisa Crump, founder of Cairn Ventures and Managing Partner, Sofia Fund. View Part I here. View Part III here.
Steps to Success incorporates advice and views in a short series of blogs, based on my experience as a tech entrepreneur and now angel investor, specifically focused on women-led startups. Next up: setting a reasonable valuation for your company. Determine first what you consider a successful exit for your company and yourself. Then walk through the funding requirements to get to this exit goal. The underlying question is, does your goal realistically align with your prospective investors?
When an entrepreneur decides it’s necessary to seek OPM (Other People’s Money) in order to scale for the market opportunity, then prospective investors become part of the funding equation and exit consideration. What is the company’s value and how much do you sell? How many rounds of financing do you likely require to get to cash flow positive or the growth capital desired? Investors want to see the founding team’s passion, optimism and leadership to achieve milestones. Experience tells us that pro-formas and timelines many times are way off expectations. It’s the condition of ‘Entrepreneur’s Over Optimism.’ (Yes, I’ve had this condition too.) We need a bolus of optimism to share vision and drive through rough patches, but sometimes it can also hold us back when needing to do a ‘reality check.’
Value the company too low and you may have less equity in the company at the time of exit, but the trade off is having a larger company, given the resources investors bring, which means your shares are worth more in the end. Value it too high and you risk not getting funding or ultimately face the challenge of having a down round in future funding.
Finding the right valuation is a vital foundation to enhancing the chances for your success. Setting a reasonable valuation helps manage your expectations of the amount of funding you can attract from an investor, while managing the expectations of what the investor can anticipate in return.
What can be considered a reasonable valuation?
According to the most recent research from the Center for Venture Research, for 2018, “the average angel deal size was $349,620 and the average equity received was 12.1% with a deal valuation of $2.9 million.”
Angel Funders Report (2018), with a dataset of 1,170 deals provides a (wide) valuation range by round: Pre-Seed: 45% of deals were in the $2.5 – $4.5M range and 27% of deals were in the $4.5 – $8M range; Seed: 31% of deals were in the $2.5 – $4.5M range and 47% of deals were in the $4.5 – $8M range.
The Halo Report (2017), with a dataset of 3,617 deals, indicates the median pre-money valuation for angel-backed deals is $3.5 million with an average deal size of $637,000.
Recent statistics like this will help you level-set your own valuation based on the current investment environment. Valuations can also vary based on industry or geography. Keep in mind the number of rounds and amount of funding you will need and the progress to milestones necessary in order to secure the funding. If these are misaligned, then you risk a down round, which becomes problematic both for the company and the current investors. Also remember that typical angel investors shoot for a 10X return on their investment at exit. This is because the majority of an angel’s capital returns come from only 7-11% of an angel’s exits, so they must achieve a higher multiple to balance out and benefit from the total portfolio of their holdings.
There are multiple methods that can be used to help determine a valuation for a pre-revenue company. These varied approaches factor in risks, assumptions, total financing needs and timeframes to exit. More information can be found on the Angel Capital Association website.
I’ve had the privilege to meet many visionary entrepreneurs with great companies, but sometimes haven’t invested. Why? Because their valuations are (sometimes extreme) outliers on the valuation continuum. Setting a reasonable valuation gives shareholders confidence that they will be rewarded for the risk and uncertainty of all the variables on the road to an exit.
I invite you to apply to Sofia fund if you are a woman-led, tech-enabled company seeking funding or a co-investor interesting in collaboration. Visit www.sofiafund.com for more information and continue to follow Sofia Fund for future blogs from my entrepreneurial viewpoint. Still to come: Conserving Cash, Tapping Resources and Achieving Exit – all steps to ultimate success for a startup.