Pre-money valuation is hard. It’s a total guess. And, if you’ve been paying attention to this blog lately, you probably know that I’ve been helping to create another company. This one has the most promise of any other I’ve built yet. Although I’m not going to reveal the details of the product/service quite yet (which is generally against my current business principles, but hey, I’ve got partners this time and some heavy logistics to work out), I do want to describe some of the things I’ve been learning along the way.
Now, I’ve founded companies in the past and sold them successfully. However, I’ve always used my own money to build them, which works out pretty well because you get to sell it however, whenever, and for whatever you think it’s worth.
When you start looking at pulling in outside investment, though, things change a bit. So, here’s the formula we worked with, for better or worse.
Side note: if you know anything about this arena and find fault in how we did things, feel free to say so. I’d love to learn more, and I know my readers would respect the info as well. Although I talked to some smart folks to come up with this, I don’t have it all figured out.
Here’s a few known variables regarding expected ROI:
1. VCs expect 5-10x their money within 3 years.
2. Angels expect 5x their money within 5 years.
We changed ours a bit because we’re bashful. We wanted our angel investor to get 5x in 3 years. So…
3. Our growth rate for revenue at year 3 is about 130% annually.
4. Let’s assume our angel wants 5% of our company.
- Start with an exit year (we took year 3).
- Take the expected revenue that year ($20M) and multiply it by what percentage ownership our angel wants (5%). $20m x 5% = $1m
- Our angel expects a 5x return within these 3 years, so let’s back that out to today by: $1m / 5 = $200k.
- That $200k is what we would expect they would invest today to get 5x their money in 3 years. So, the rest is pretty easy if they want to own 5% of the company. $200k / 5% = $4m.
- So, today our company would be valued at $4 million.
Now, these numbers are pretty fictional. So, let’s just say we we didn’t want to estimate quite so high. We thought that was a bit presumptuous, just as a hunch. So, we recalculated the numbers based on profit instead of revenue. For our model, let’s just say that got us closer to a $1.2m valuation, which seems a bit closer to expectations.
Anyway, that’s how we did our pre-money valuation. If you’re doing anything else, then forget everything I just said and go listen to these guys chat about cap tables. They know what they’re talking about.
[tags]finance, money, corporate, valuation, company, pre-money, estimate, angel, vc, venture capital[/tags]