Two Birds, One Stone

Valuation seems to be one of the tougher questions to answer when starting up a new venture - especially if it is your first time. I understand (for the most part) how many of the various models work, having learned many of them during my MBA. Now that I’m nearly finished school and out trying to get my company, MemoryLeaf, off and running, I’m finding the question of valuation a bit daunting. Helpfully, Jordan Cooper just posted a seed stage valuation guide which helps answer some of the questions. Am I valuing my planned funding rounds high enough to not dilute myself out of the picture in future rounds, but low enough that I can attract investors and not have down rounds of future funding? Is my pricing attractive enough for employees receiving stock options? It’s all a bit scary and seems ridiculously error prone… and ultimately, subject to the whim of “he with the money”. Essentially it all boils down to making a whole bunch of assumptions and making an educated guess. I’ve used two models: The VC Method where you estimate an exit valuation (likely based on some multiple of revenues or earnings or a mix of the two) for some time horizon, then discount that back through your various funding events with a (fairly high) discount rate (50%+). In this case, the investor’s risk is incorporated into the high discount rate with the aim to yield desired returns over several parallel investments. I find this to be the easiest to use as it requires few inputs but feel a bit awkward making 7-10 year projections with multiples that could change. I also use my instructor Thomas Hellman’s PROFEX model (scroll to the “Teaching Materials” section). PROFEX stands for PRobability OF EXit. In PROFEX you estimate the probability of exit, failure, and subsequent funding for each round and corresponding valuations for each scenario. This allows you to model the risk separately so you can use a more meaningful discount rate giving a true rate of return. It also allows for valuation of failure (fire sale of assets, etc). I like this model a lot as it makes you think more critically about each round and seems to be less forgiving than the VC model. However, it requires a lot of inputs and because it uses a whole different set of assumptions, your outputs will likely be vastly different than the VC model. Also, no one really uses this - yet. Being a first-time startup, it’s difficult to know if these valuations are in the realm of reasonable or not. It’s best to try and proxy against other similar events happening around you, which, in itself, can be difficult to know. Having a good, connected lawyer helps and keeping up with the news. It’s also great when someone in the industry blogs about what is going on and gives some ranges to compare yourself against. Thanks to Jordan Cooper for posting his seed stage valuation guide. Now I feel validated a bit more in my assumptions.