Deciding on Valuation

Valuation for a startup in the early days is super hard. When you get to later stages, you will have more clear comps for your revenue, user base, and growth metrics that make it a bunch easier. But how do you set the valuation on a company with limited traction? I usually give founders the same answer that I give my wife when she asks what our house is worth, “It’s worth what someone else is willing to pay for it”.

If you are raising a round with an institutional lead investor, they will issue you a term sheet and set the valuation they are willing to pay. That’s an easy case, you either agree to take their money at their price or you don’t. But if you are raising money a little bit at a time from smaller investors, you get to set the valuation and then see if you can sell investors on the number. Many founders say, “we’ll be using a convertible note or SAFE so the valuation is just a cap”, but that is not how investors will see it. They will expect you to raise in the future at a price above the cap, so they will see the cap as their entry price. I typically see caps on first rounds set between $5–10MM, with companies selling a 10–20% stake.

OK, full disclosure, we usually invest in Seed rounds so of course I prefer lower valuation caps. That’s just obvious from an investor, but I think it makes a lot of sense for founders too. The first serious outside money is so hard, and if you don’t get it chances are your company is never getting to a Series A anyways. I usually advise founders to set a generous valuation cap and get that first raise done faster and easier. And don’t even show me a deal with no valuation cap at all. I’m taking a ton of risk investing this early, so I expect to be rewarded.

Getting the right early investors on board helps with future raises, hiring, and customers. There are so many reasons for an investor to say “no”, in the early days don’t make valuation another reason. Plus if you set a higher valuation cap, you will need even more traction to get the Series A done properly.

Thanks for reading today’s post, I hope this helps you with pricing for your capital raise.