Venture Capital Funding Startup Guide
Calculate pre-money valuation of startup company seeking venture capital funding
pre-money valuation, startup company, venture capital funding, discounted cash flow model, DCF
Pre-money valuation - the basic concept
The calculation of the pre-money valuation of a startup company seeking venture capital financing is as much a science as an art. It is a science because a lot of the calculations are based on scientific methods - the use of equations, formulas, comparators, etc. It is an art because inevitably there will be guesswork involved as the fate of a startup company can often defy reasonable expectations - both good and bad. Bearing that in mind, it is important to eliminate as much guesswork as possible, and to come up with a valuation that both founders and investors are willing to accept.
Below are examples that business analysts use in calculating the pre-money valuation of a startup company.
The Discounted Cash Flow Model ("DCF")
The discounted cash flow model involves estimation of future cash flows and discounting them to their present values using the time value of money. It is often used to estimate the present value of a project or a company.
Discounted P/E ratios
Multiplication of discounted P/E ratios by periodic earnings.
Comparators
Comparative analysis to comparable private and public companies.
Problems and difficulties in calculation
Calculation of pre-money valuation is often difficult because of the lack of information. A startup company only has a limited historical record, and often is still in its early stage of development or R&D stage at the time of investment. Comparable private and/or public companies may sometimes be difficult to find if the startup company has a special unique feature of its own.
Pre-money valuation may not be that important
Ultimately, what pre-money valuation does is it determines how much an investor has to pay for what percentage ownership of a company. The pre-money valuation puts on a company in a venture capital financing round may not have much significance in the valuation of a future financing round, if the company performs extremely well or extremely bad following the previous financing round.
Valuation vs. Control
What is more important than valuation is control. For example, liquidation preference, rights attached to preferred stockholders, etc. Instead of asking "How much is my company worth?", entrepreneurs perhaps should also ask themselves "How much control am I giving away in this financing round?"
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