Valuations & Price
A funding round's "valuation" or "price" is an important figure that represents the value of the company being funded. This section contains the resources you need to set and understand this term.
Posts by Month
Last week on MBA Mondays, I talked about valuing an internet marketplace business. In that post, I talked about using 1x gross marketplace transactions and 20x EBITDA as multiples to determine value. In the comments, I was asked about multiples for other sectors. That's a good question so I figured I'd show how to calculate multiples for various sectors.
Let's assume we have a portfolio company. I will call it fit.sy. It is a marketplace for fitness experiences. We invested in it last year as it was
getting ready to launch. A year later the business is scaling nicely and needs more expansion capital. The founders don't really want to go out and do a fundraising process. So they have asked the existing investors to make them an offer for an internal round. They believe they need $3mm of expansion capital to get them to cash flow breakeven. So now the VC firm (us) needs to figure out what is a fair price.
Come up with what minimum valuation you’d be happy with but never share that number with any investor. If the number is too low, you’ve set a low ceiling. If your number is too high, you scare people off. Just like on eBay, you only get to your desired price by starting lower and getting a competitive process going. When people ask about price, simply tell them your last round post-money valuation and talk about the progress you’ve made since then.
Suppose there is a pre-profitable company that is raising venture financing. Simple, classical economic models would predict that although there might be multiple VCs interested in investing, at the end of the financing process the valuation will rise to the clearing price where the demand for the company’s stock equals the supply (amount being issued). Actual venture financings work nothing like this simple model would predict. In practice, the equilibrium states for venture financings are: 1) significantly oversubscribed at too low a valuation, or 2) significantly undersubscribed at too high a valuation.
One of the more contentious things in the negotiation between an entrepreneur and a VC over a financing, particularly an early stage financing, is the inclusion of an option pool in the pre-money valuation. As my friend Mark Pincus likes to say, "it's just another way to lower the price". I'll accept that critique. And take it one step further. The option pool is absolutely a piece of the price negotiation. But it is a very important one as I'll explain.