Pillar 2. Introduction to Raise Amount & Valuation
Why is your raise amount & valuation so important?
This is a huge question every founder raising funding needs to know and understand. It’s about protecting your most valuable asset, your ownership stake. This is one of the most subjective areas when trying to find a suitable valuation and with the raise amount so intrinsically to it as they define how much of your company you are giving away, then it’s an area you need to brush up on as the cost of mistakes is significant.
You need to consider the life of your startup’s capital needs and consider if there are 3 – 4 potential future capital raises, what kind of scale they may be, then how much will you be left with each time.
Far too many founders find themselves 3-4 years in and only holding a small % as they’ve diluted themselves down and down on the back of things not going according to plan. This is the unfortunate reality. We can’t see into the future, but we can have an understanding for likely scenarios and at least be aware of the potential impacts.
Your raise amount and valuation level are critical in protecting your most valuable asset; the amount of your company you retain and control. Model a few scenarios to understand how this may look over time.
So, the saying that early rounds are the most expensive rounds hits the nail on the head in the early years for Startups. There is a huge balancing act between how much you decide to raise and the valuation you can raise it at. It’s not simply a case of saying I want to raise £100k and that’s it, because if you are unable to raise at an acceptable valuation level at that point then you are giving away a high % of your company early on.
Example 1 : Shows the different views a founder and investor may have on early valuation
Investor;
Pre money valuation £400k for £100k raise = £500k post money for 20% of the business
Founder;
Pre money valuation £900k for £100k raise = £1m post money for 10% of the business
There is a natural conflict between where the investor sees the valuation now v the founder applying some element of future value and the dilution impact is significant. Therefore you have to juggle what you really need, and how much of your company you are comfortable selling, as it maybe better to raise in 6-12 months when you can get a £900k pre money valuation more justifiably.
Early investment rounds are the most expensive rounds as little is proven and you need to sell a higher than desired level of equity. So balance your raise amount with your valuation with care.
Valuation
To many an outsider it often appears like black magic and a wet finger stuck in the air for a best guess on valuation and the truth is a lot of the time it probably is. Despite a vast array of qualitative and quantitative valuation methodologies, early stage companies don’t have a consistent and reliable single method to rely on as it’s purely the crossroads between what a Founder perceives its worth based on future potential versus an investor seeing the company’s worth today.
The nature of markets has a very positive or negative impact on valuations, I.e. Sexy sector valuations provide an easy reference point to boost your justification, but when it’s no longer flavour of the month, it can make things much harder.
So, just like pricing your product, your valuation amount is merely a case of setting a level you feel can be justified and offering value to all, then finding enough parties who are willing to pay the price you are asking. There may be plenty of interest, but the price has to be right for all concerned.
Common mistakes
There are several common mistakes that occur in this areas, so to open up the subject slowly here are some worked examples: ,
1. Pre & Post Money
The often mis-understood issues of pre & post money can catch many first time founders cold, whereby the valuation doesn’t add on the raise amount, so effectively undervaluing the company. The example below shows the impact of an early round costing the founder 3.33% which is significant if they don’t quote them properly.
Example 2: The impact of pre & post money valuation calculations
Situation 1;
Pre money valuation £500k for £100k raise = £600k post money for 16.67% of the business
Situation 2;
Pre money valuation £400k for £100k raise = £500k post money for 20% of the business
A pre/post money mistake could cost hundreds of thousands or millions in future value on exit.
2. I want to raise £250k for 2.5%
It’s not uncommon for a raise amount and the % for sale to be put forward but with no appreciation for how much this actually values the company. In this situation, the company is being valued at £10m post money, which if this is an early stage, pre traction business, it will be pointed out by an investor and require you to promptly revise it downwards significantly.
3. Raising too much too early
Prior to going out to market, inexperienced founders may be convinced they want to raise £2m immediately for their incredible idea. They don’t want to raise several rounds, they just want to go big and execute, “this can’t fail”! Word of caution, unless you are a proven entrepreneur or the idea is heavily patented and has customers all lined up with pre-orders, then odds are investors won’t even open your deck. You won’t be able to justify the valuation and you have proven little at this point as a founder or business. You should look to raise from positions of strength, which involves multiple traction proof points, revenue, strong user growth and risk of undersupply because customer demand is so high.
Raise in stages, prove, increase shareholder value, raise at a high valuation, build a track record.
4. Raising at too a high valuation
This is very common and very dangerous. It usually results in one of these items;
Long & hard raise process
If you go in too high, but an investor is interested if you will negotiate then they simply don’t see the risk to reward ratio worth it unless you come down. They may naturally be trying to squeeze some more value out, but if your general feedback is you are consistently valuing your business to high then it’s key to listen and avoid several rounds of negotiations with investors as it may become damaging to the relationship if they are on opposite spectrums and neither party feels like they have a fair deal. Confidence should be taken into any fundraise to justify your valuation, but with a level of evidence and pragmatism and knowing the true value the investor brings as to how hard you try to stand your ground. If you keep stumbling on valuation then the rounds risks dragging which may then impact other investors confidence and distractions to you running the business.
Trying to save face
The second issue with this is that if you then need to reduce your valuation down significantly then you may be losing a lot of leverage or face if you have to go back around to investors you’d skipped over previously. It may have left a sour taste in their mouth and their excitement gone. So factor in the importance of momentum in any round is key, the longer rounds go the more confidence from other potential investors disappears.
The dreaded future downround
You’ve raised at too high a valuation with too optimistic financials, then you find yourself needing more funding but with the only option of dropping the valuation to make it attractive for investors and reducing the value of the prior rounds investors. Needless to say this is completely undesirable and sometimes unfortunately unavoidable, but by raising at a sensible level initially then you stand a better chance to show consistent growth in the business value round on round.
Raising at too high a valuation can really impact your future chances to raise. It’s better to be more conservaitve than too aggressive because too high a valuation may impact both your current and future rounds.
5. Being too conservative on your valuation
In the same vein, some founders are too conservative in early rounds as there is little traction to substantiate too high a value and they may not have the level of confidence to stand behind, so they opt for something too low and give away too way much. There is merit in the intentional benefit of speed and obtaining key investors, so you effectively incentivize them with a lower valuation, but ensure you distinguish the two.
6. Overfunding
The opportunity comes along to raise more money than you initially planned, so you decide to take it and overfund. Brilliant you think, more cash, longer runway, more comfortable position, etc. However, you’ve just sold more of your company at a high price tag. Was that extra £50k really worth giving away more of your company, when you could have raised a bit more on your next round at a 2-4x higher valuation?
These are some early insights into the area of raise and valuation, but be aware when trying to set both amounts;
Objectives for this pillar
- You are trying to raise enough money to achieve your next set of milestones
- Each round should create significant shareholder value from growth in share price.
- The amount you are looking to raise should be achievable
- Make the investors an offer that is attractive and not a turn off
- Win next investors for the journey and future rounds
Risks of getting it wrong
- Don’t get greedy and set too high a valuation
- Avoid a long drawn out raise process that causes significant distraction to the business
- Don’t alienate investors early, burning the bridge for the future
- Raise try to raise too much and set an unachievable target
How we help
To make it simple, within our platform on our paid plans FundingHero has broken this area down into 4 easy to use tools so you can arrive at a suitable raise amount and valuation with a carefully considered thought process, along with some thoughts on exit headlines to really warm up and excite prospective investors.
- Raise amount canvas
- Valuation canvas
- Valuation justification
- Exit headlines canvas
Use these canvases as useful prompts and considerations before you finalise your most important numbers for your fundraise.
Fundraising shouldn’t have a 99% failure rate…
FundingHero is your all in one platform for tech founders looking to raise their early stage funding. We teach you the rules of fundraising to help you to Learn, Prepare & Raise.
Our platform gives you access to:
- Online canvases & templates
- Detailed Fundraising library
- Fundraising dashboard & raise trackers
- Simple investment tools
- Large investor directory
If you need help then contact us at [email protected] or sign up to our freemium version now to sample how easy our canvases are to use and take your first steps to smashing your fundraising goals and becoming a FundingHero today!
