Pitching investors? Here’s how to figure out your startup’s valuation in 30 seconds.
30-Second Startup Valuation
Here's how to figure out how much your startup is worth before you start pitching investors. You’ll need these two things, which you probably already know:
How much money you’re raising in this round (Cash Raised)
What % of the company that “should” be worth (Ownership Percentage) according to you, your investors, or both (start with 20% if you're not sure—you can always change it later).
The formula to figure out your startup’s valuation is:
Cash Raised divided by Ownership Percentage = Post-Money Valuation.
Now subtract the Cash Raised to get your Pre-Money Valuation (what your startup’s worth now, before the investment).
Your Pre-Money Valuation is the answer to the question, "What's my startup worth?"
Here's a short video walkthrough:
Example: We’re raising $1 million for 20% of the company, so Cash Raised = $1 million and Ownership Percentage = 20%.
$1 million divided by 0.2 (20%) = $5 million Post Money Valuation. Now we subtract the $1 million Cash Raised to get a $4 million Pre-Money Valuation.
So our startup is worth $4 million now, before the investment.
That’s it! That’s literally the only Pre-Money Valuation that gives you the cash you want while also giving the investors the correct ownership percentage. This works for equity / priced rounds, convertible note valuation caps, and valuation caps for SAFEs.
Yes, you can use fancy spreadsheet models to calculate startup valuation based on discounted cash flows or net present value. The thing with early-stage startups—especially pre-revenue startups—is that all of the numbers in the spreadsheet are guesses. So in my experience that leads to weird negotiations with potential investors over made-up numbers.
This is because no one knows the future. Not even Google, who just announced that they're laying off 12,000 people last week.
I make spreadsheets for a living—and Rocket Pro Forma will calculate net present value—but trust me when I tell you it’s easier to focus on the two pieces of info you actually know: a) how much money you’re raising (Cash Raised) and b) what % of the company that % should be worth (Ownership Percentage).
This seems too easy, but it’s how I’ve raised money in the past. Here's how:
My Story
My cofounder and I were raising a $2 million Series A round, and we finally found a VC firm who agreed to invest (our path to becoming investable is an entire story that I’ll cover in a separate blog post). We hadn’t really thought about valuation, but the investors said they wanted to own “about a third” of the company.
Boom! Now we had the two pieces of info we needed to calculate the valuation:
Cash Raised = $2 million
Ownership Percentage = 1/3 or 33.3%
(Dividing by 33.3% is the same as dividing by 0.333. Plug 2,000,000 / 0.333 into a calculator to see for yourself)
Here's the math:
$2 million dollars divided by 33.3% = $6 million Post-Money Valuation - $2 million Cash Raised = $4 million Pre-Money Valuation
So our startup had to be worth $4 million pre-money.
Wait, is it really that easy? Yes.
The investors gave us a term sheet offering us the $2 million investment (Cash Raised) on a $4 million Pre-Money Valuation. This is called “two on four,” and it would create a $6 million company (because the $4 million Pre-Money Valuation plus the $2 million Cash Raised adds up to a $6 million Post-Money Valuation).
The investors would then own 1/3 of the company, because $2 million Cash Raised divided by $6 million Post-Money Valuation = 2/6 = 1/3 = 33.3% Ownership Percentage.
We thought about it for a day, and then we asked the VC firm for a $5 million Pre-Money Valuation (or a “two on five”).
What would this do to the numbers?
We would now be creating a $7 million company. because the $5 million Pre-Money Valuation plus the $2 million Cash Raised adds up to a $7 million post-money valuation.
The investors would own 2/7 or 28.6%, because $2 million Cash Raised / $7 million Post-Money Valuation = 2/7 = 28.6%.
By asking for a $5 million Pre-Money Valuation we were actually negotiating the Ownership Percentage.
Our investors said yes and we did the deal.
The result was that we saved almost 5% of equity, because 28.6% Ownership Percentage is 4.7% less than 33.3% Ownership Percentage (their original offer).
At no point during those conversations did we ever have to “prove” that our startup was worth $4 million…or $5 million. Our Pre-Money Valuation was simply a function of both parties getting what they wanted:
We got a $2 million cash investment (Cash Raised)
The investors owned about a third of our company (Ownership Percentage)
And we never had to negotiate made up numbers from our spreadsheet.
Can we skip the valuation for now?
One way to raise money is to sell equity at a specific valuation. This is called a priced round, and it's what we did in the story above. It requires you to come up with a Pre-Money Valuation—which is easy now that you know the cheat code, right?
But what if you don't want to come up with a Pre-Money Valuation right now?
The idea behind a Convertible Note is that you can delay valuing your startup, specifically until the next round of funding. The Convertible Note was created to help founders and investors move quickly, with the least amount of negotiation.
The Convertible Note has a ticking clock, meaning the next investment usually has to happen within two years (or however long you and your investors agree to). After that it's supposed to convert to Equity (shares of stock).
The SAFE is similar to a Convertible Note, but removes the ticking clock. So a SAFE can sit forever without converting.
The thing with both Convertible Notes and SAFEs is that investors often want a valuation cap (here’s the full story on valuation caps from Y Combinator).
So you’re back to figuring out what your startup is worth in order to create the valuation cap.
Again, the 30-second method that I’ve laid out in this blog post is the easiest way to make everyone happy.
Why have a valuation cap? Because it protects investors if you hit a home run. For example, if you raise $100,000 from investors using a Convertible Note and then create a $100 million company, their $100,000 doesn't give them very much of an Ownership Percentage. But you needed their money in order to succeed.
So the valuation cap protects investors by saying that their $100,000 will convert to equity at no more than a $1 million valuation (for example).
Trick Question
If your investors put $200k into your startup (Cash Raised) with a $1 million Pre-Money Valuation, what with their Ownership Percentage be?
Take a minute to think it through.
Hint: Ownership Percentage = Cash Raised divided by Post-Money Valuation.
Here's a walkthrough of your Startup's Post-Money Valuation (using different numbers so we don't give away the answer to the trick question yet):
Definitions
We’ve discussed enough things that we a list of definitions. You'll find every term in this list is capitalized throughout this blog post. This is your cheat sheet when you’re getting ready to pitch investors.
Pre-Money Valuation is the answer to “What’s my startup worth?” It’s what your startup is worth now, before the Cash Investment.
Post-Money Valuation is the Pre-Money Valuation plus the Cash Investment. You and the investors work together to create the Post-Money Valuation, because you add their cash to your existing company.
Cash Raised is the amount of money being invested into the company.
Ownership Percentage is how much of the company the investors own after they invest. It’s calculated as Cash Investment divided by Post-Money Valuation.
Equity means shares of company stock that represent actual ownership.
A Priced Round is when you raise money from investors by selling shares (Equity) of your startup at a specific valuation. This is how we raised money for our startup in the example above (My Story).
A Convertible Note is a loan to a startup that will convert to Equity (shares of stock) within a certain period. It’s a founder-friendly way to raise money.
A SAFE (Simple Agreement for Future Equity) is similar to a Convertible Note, but doesn’t have a time limit, and so may never convert to equity. It’s even more founder-friendly than a Convertible Note.
A Valuation Cap is designed to protect your investors in a Convertible Note or SAFE if you create a high-value company without needing to raise more money.
Answer to the Trick Question
If your investors put $200k into your startup (Cash Raised) with a $1 million Pre-Money Valuation, what with their Ownership Percentage be?
Hint: It’s not 20%.
You'll create a $1.2 million Post-Money Valuation company ($1 million Pre-Money Valuation plus $200k of Cash Raised), of which the investors would own 2/12 or 16.7%, because $200k / $1.2 million = 2/12 = 1/6 = 16.7%.
Answer: Their Ownership Percentage would be 16.7%.
And this is why it's important to only talk about investor Ownership Percentage in relation to the Post-Money Valuation. Founders who accidentally talk about Ownership Percentage in relation to the Pre-Money Valuation end up with confused—and possibly disappointed—investors.
That's it! Now you have everything you need to figure out what your startup is worth in 30 seconds.
Mike Lingle is the founder of Rocket Pro Forma (financial projections for Web2 and Web3 startups), CFO at Security Token Group (digital asset securities on the blockchain), and an entrepreneur-in-residence at Founder Institute. He co-founded an online slide presentation app that was acquired by VMWare in 2011.