This post is dedicated to all startups pre-money - the ones which didn’t receive their first round of real capital yet (grandma’s donation doesn’t count). If you already received either a round of professional angel/seed capital or are even through a VC round - stop reading! You’ll be bored to death! If you are in the situation that you are trying to raise your first round - read on…

So - you thought long and hard about your business plan, your presentation and feel ready for the pitch (and to do so you’ve read Guy Kawasaki’s “The Art of the Start” cover to cover - and back). You’ve got all the pieces together and you know how much money you ideally want to raise. But wait - have you also thought about the valuation of your company? I mean - thought about it deep and long? Really deep and long?

A lot of early stage startups haven’t (at least the ones I tend to see - which might be a problem originating from me) - and run into trouble the moment they pitch. At the very least they show that they haven’t understood the fund raising process. At the worst they make fools out of themselves and won’t get any funding.

But before we go into details, here’s a super short primer on valuations: The valuation describes the monetary value of your company. With an established company the value of the company is often calculated on something like x-times yearly revenue or some other more or less crude formula. As you have a startup which often doesn’t have real revenues, customers or even a finished product, your valuation is more like a fantasy. There is no right or wrong - the value of your company lies in the eye of the beholder. Which is the exact reason why valuations are tricky - you think your company is the next Google and thus already worth at least half-a-gazillion. An angel investor might see this slightly different - he sees a single guy without a product or team - and certainly no customers or revenues. For him your company might be worth anything from nothing to “a little bit”.

Now comes the really tricky bit - time and time again I see entrepreneurs with barely anything else but a business plan and (if lucky) a half-way working prototype asking for anything from 250,000 to one million in funding. They did the maths - and their plan clearly shows, that this is the amount of money they need. Only - they never really thought about valuation.

Let me explain: If you are asking for let’s say half a million and are willing to give away 20% of your company for this money, your pre-money valuation is a whopping 2.5 million. Not bad for a company which doesn’t have any revenues. A sane angel investor will value your company probably with something like 750,000 - which means that for half a million he would need to get 2/3 of your company. Not very realistically - is it? This is the moment when you demonstrate that you haven’t understood the rules of the game.

Now it gets worse: More often than not I see entrepreneurs asking for half a million in exchange for 5%. Their reasoning: It’s an angel round - and everybody knows that angels only get small stakes. Now - 5% for half a million values your company at a totally insane 10 million pre-money. In a word - you just proved that you are a clueless fool. And nobody invests into a clueless fool.

So - think about your valuation. As a rule of thumb: If you have an idea, a business plan, a half-way working prototype and the foundations of a team your company might be worth somewhere in the range of a million. If you have less - your company will be worth less (and yes - there are obviously exceptions to the rule; but believe me - they are rare).

Posted in Entrepreneurship