For business owners, startup valuation is a topic that causes lots of angst, raises tons of questions and definitely gets emotions blazing. But let’s take a step back.
They are what an investor, acquirer or the public (via an IPO) is willing to pay for your business. They are based on intangibles such as the quality of your founding team, the size of your market opportunity and how hot the space you’re focused on is.
Besides determining things such as the amount of equity you give up for funding and how much value you are able to extract from your company in the long-term, valuations are important for demonstrating how attractive your business is to investors and for showing how you compare with industry peers.
VCs are looking to make home runs with their investments. Out of ten investments a VC makes, five will fail, two will break even and one to two investments will be home runs. Because of that, VCs place a lot of value on the size of the opportunity.
Here’s another tip: very few VCs are visionaries. Most VCs are “fast followers” who move in herds. In other words, when it comes to your valuation timing, whether your sector is in or out of favor really matters.
Here’s how to increase your startup valuation:
1. Have a previous successful exit.
“Selling a company is very different from selling a product,” says Erik Bovee, a founder and general partner in SpeedInvest. “The perception of risk on the part of the buyer is different, and there are often far more people involved than at any other significant event in the life of your company. An acquisition is a very, very fragile thing. And it often takes much longer than you planned (VentureBeat).” However, this will increase your chances not only of getting funding but also of raising it at a higher valuation.
2. Select your team carefully.
You should always hire deliberately, but if you know you plan to raise equity funding, choose your hires especially carefully. Pick people who don’t just have an area of expertise, but who are also leaders in their chosen field.
3. Pick milestones that matter.
Milestone financing, provided you hit your milestones, increases your startup valuation with each funding round. They could be around technical development (beta versions or prototypes of your product), customer traction, or team goals, but they should be specific to your business. Be thoughtful when defining milestones. You’ll lose credibility by choosing ones that you can’t hit. Once you’ve identified them, build your budget based on your expected costs to achieve them. That will determine the size of your ask. Always include a 25 percent fudge factor to account for unexpected speed bumps or delays.
4. Lower your burn rate.
While traction means different things to different people, investors will always look at your burn rate versus your growth rate. Seattle investment company Lighter Capital, for instance, looks for burn rates longer than six months when it considers extending revenue-based funding to startups.
5. Negotiate your fundraising.
The more interested parties you have, the higher your valuation will be. As part of your negotiating strategy, let VCs come up with numbers first; then play investors off each other. Don’t commit to anything until all the information is out there and you know how high a valuation you can get.
The whole concept of dilution — the more you raise, the more equity you give up — means you want to have as high a valuation as possible, but you need to balance it with your future funding plans so that you don’t arrive at a price that can’t be supported by the market.
This article has been edited and condensed.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, an outsourced financial services firm that provides early-stage companies with day-to-day transactional accounting, CFO service, tax, and valuation services and support. He’s a financial expert and startup mentor whose passion is helping businesses focus on what they do best. A version of this article originally appeared on the author’s blog. Connect with @EarlyGrowthFS on Twitter.