When Raising Equity Why would you want to know your valuation? So you know how many shares you have to give away when you raise money with an investor. Assume you want to raise 400,000. Assume the valuation of your is 1,361,772. Then you have to give away 400,000 / 1,361,772 = 29.4% of your shares to the investor. startup You can raise this 400,000 either with equity or a convertible. Assume you raise this money by issuing equity. [Read if you do a convertible] this Then you can your startup in 38 steps. value Yes, that is a lot. But what are your options? Should you take a guess? Good chance that your valuation is either too high or too low. A valuation that is too high means giving away too few shares. Giving away too few shares means no deal. A valuation that is too low means giving away too many shares. Who wants that? Or should you ask the investor? That’s like asking someone how much he would pay for your house. What do you think? Will he come up with the highest price? Or will he try to lowball you? Anyways. About those 38 steps. Steps 1–7: Cashflow planning Step 1: Map out 60 months To simplify only the first 6 months are shown. Assumptions are in blue. Calculations are in black. Step 2: Estimate products/month How many products will you sell each month? To simplify rounded numbers are shown. Calculations use the unrounded numbers. Step 3: Estimate price/product What is the price per product? Step 4: Calculate cash in/month Products/month in month 1 is 1. Price/product in month 1 is 2,000. So cash in/month in month 1 equals 1.1 * 2,000 = 2,000. Step 5: Estimate cash out/month What is the cash out each month? Step 6: Calculate cashflow Cash in/month in month 1 is 2,000. Cash out/month in month 1 is -24,219. So cashflow in month 1 equals 2,000 + -24,219 = -22,219. Step 7: Calculate cash end Cash end in month 0 is 0. So cash begin in month 1 equals 0. Cashflow in month 1 is -22,219. Equity in month 1 is 0. So cash end in month 1 equals 0 + -22,219 + 0 = -22,219. Steps 8–10: Milestones Step 8: Define milestones When is your startup significantly de-risked? Assume with each 10x in products/month. A very crude rule of thumb: 10x for software and 5x for hardware. Products/month in month 0 is 0. So the first milestone would equal 0 * 10 = 0 products/month. That doesn’t work. Therefore, if products/month in month 0 is 0, temporarily assume it is 1 when you define milestones. So milestones are: 1 * 10 = 10 products/month 10 * 10 = 100 products/month 100 * 10 = 1,000 products/month Etc. Step 9: Look up month/milestone Look up each milestone in your cashflow planning. You have 3 milestones: 10 products/month in month 24 100 products/month in month 48 Because 1,000 products/month is outside your 60-month horizon, use the 316 products/month in month 60 Step 10: Look up investment/round Before investment, you have a negative cash balance. How much money do you need to achieve each milestone? _Milestone 1_To get from 0 products/month in month 0 to 10 products/month in month 24, you need to raise a Series Seed of 400,000 in month 0. This keeps your cash balance at 0 or more. _Milestone 2_To get from 10 products/month in month 24 to 100 products/month in month 48, you need to raise a Series A of 1,000,000 in month 24. _Milestone 3_To get from 100.0 products/month in month 48 to 316 products/month in month 60, you don’t need to raise any more money in month 48. Your cash balance is already 0 or more. Steps 11–12: Funding strategy Step 11: Choose Series Seed instrument Which instrument will you use for your Series Seed: equity or a convertible? Assume you raise your Series Seed with equity. [Read if you do a convertible] this Step 12: Choose Series A instrument Assume your raise your Series A with equity. Steps 13–17: Exit Step 13: Map out rounds Map out the rounds identified in the previous step. Include the exit. Step 14: Calculate revenue/year Cash in/month in month 60 is 632,000 (from cashflow planning). So revenue/year @exit equals 12 * 632,000 = 7,584,000. Step 15: Look up revenue multiple How much are investors willing to pay for a company in your region and industry, with a revenue/year of 7,584,000? Assume 4.0x revenue/year (market data). Step 16: Calculate enterprise value So enterprise value @exit equals 7,58400 * 4.0 = 30,336,000. Step 17: Calculate equity value Cash end in month 60 is 3,684,194 (from cashflow planning). So equity value @exit equals 30,336,000 + 3,684,194 = 34,020,194. Steps 18–28: Series A equity Step 18: Look up IRR/year portfolio How much does the Series A investor want to make on his portfolio? Assume the IRR/year on his portfolio is 20.0% (market data). Step 19: Calculate years till exit The Series A investor exits after (60 –24) / 12 = 3.0 years. Step 20: Calculate money multiple portfolio So the Series A investor wants a money multiple on his portfolio of (1 + 20.0%) ^ 3.0 = 1.7. Step 21: Look up milestones till exit How many milestones does the investor have till exit? The Series A investor invests at 10 products/month in month 24 (from cashflow planning). So he has 2 milestones till exit: 100 products/month in month 48 316 products/month in month 60 Step 22: Estimate probability/milestone What’s the probability to get from one milestone to the next? Either you get there, or you don’t. So 50/50. Assume a 50.0% probability to get from 10 products/month in month 24 to 100 products/month in month 48. And assume a 50.0% probability to get from 100 products/month in month 48 to 316 products/month in month 60. Step 23: Calculate probability till exit So the probability to get from 10 products/month in month 24 to 316 products/month in month 60 is 50.0% * 50.0% = 25.0%. Step 24: Calculate sub So the Series A investor has a sub (for lack of a better word) of 1.7 / 25.0% = 6.9. Step 25: Calculate retention Because there are no more shares issued after the Series A, the investor retains 100.0% of his initial share percentage. Step 26: Calculate money multiple startup So the Series A investor wants a money multiple on your startup of 6.9 / 100.0% = 6.9. Step 27: Calculate post-money valuation So your startup has a post-money valuation @Series A of 34,020,194 / 6.9 = 4,921,903. Step 28: Calculate shares% Investment @Series A is 1,000,000 (from cashflow planning). So you have to give away 1,000,000 / 4,921,903 = 20.3% of the shares to the Series A investor. Steps 29–38: Series Seed equity Step 29: Look up IRR/year portfolio How much does the Series Seed investor want to make on his portfolio? Assume the IRR/year on his portfolio is 20.0% (market data). Step 30: Calculate years till exit The Series Seed investor exits after (60 — 0) / 12 = 5.0 years (from cashflow planning). Step 31: Calculate money multiple portfolio So the Series Seed investor wants a money multiple on his portfolio of (1 + 20.0%) ^ 5.0 = 2.5. Step 32: Look up milestones till exit The Series Seed investor invests at 0 products/month in month 0 (from cashflow planning). So he has 3 milestones till exit: 10 products/month in month 24 100 products/month in month 48 316 products/month in month 60 Step 33: Estimate probability/milestone Assume a 50.0% probability to get from 0 products/month in month 0 to 10 products/month in month 24. Assume a 50.0% probability to get from 10 products/month in month 24 to 100 products/month in month 48. And assume a 50.0% probability to get from 100 products/month in month 48 to 316 products/month in month 60. Step 34: Calculate probability till exit So the probability to get from 0 products/month in month 0 to 316 products/month in month 60 is 50.0% * 50.0% * 50.0% = 12.5%. Step 35: Calculate sub So the Series Seed investor has a sub of 2.5 / 12.5% = 19.9. Step 36: Calculate retention Because there are more shares issued after the Series Seed, the investor retains 100.0% — 20.3% = 79.7% of his initial share percentage. Step 37: Calculate money multiple startup So the Series Seed investor wants a money multiple on your startup of 19.9 / 79.7% = 25.0. Step 38: Calculate post-money valuation So your startup has a post-money valuation @Series Seed of 34,020,194 / 25.0 = 1,361,772. So what is your valuation? 1,361,772. OMG, finally! That’s how you value your startup when issuing equity. Now you know how many shares you have to give away. And now you can compare issuing equity against . doing a convertible Thanks to Chretien Herben. Joachim Blazer is the author of The #1 Guide to Startup Valuation .
