Relationship between fundraising and valuations in EU countries
Investors in Europe typically expect your valuation to be about 3–4x new funds raised, and that your next round should be roughly 5x more than your previous one.
But where’s the starting point? If your valuation is a function or multiple of how much you managed to raise the very first time, how much should you raise? What should be your ask? In that very first round you need to get about 15 months runway from the new investment. Your ask should be directly tied to your go-to market strategy and your application of funds in those 15 months. We discuss fundraising in more detail in a separate blog post.
To focus purely on startup valuations, this article takes a closer look at some of most commonly used early-stage / pre-revenue angel and venture capital valuation methods.
The other side of the Table
Behind the scenes, conventional wisdom among investors is that valuations become less of a science and more of an art the younger the startup and the less developed a market. Valuations however still need to be based on something of substance, a methodology. Below are the most common valuation methods used in the Venture Capital World.
Best practice suggests using at least three startup valuation methods to estimate the appropriate pre-money valuation. If all give roughly the same number, investors simply average the three. If one is an outlier, then they average the other two, or alternatively use a fourth method in an attempt to bring the three of them in close agreement.
Market Comparables Method – The market comparables method attempts to estimate a valuation based on different ratios of similar competing startups or startups with a similar target audience and pricing schemes. Investors use ratios such as earnings, sales, and R&D investments, and extrapolate these to arrive at a valuation.
Venture Capital Valuation Method – venture capital method reflects the process of investors, where they are looking for an exit within 3 to 7 years. First an expected exit price for the investment is estimated. From there, one calculates back to the post-money valuation today taking into account the time and the risk the investor takes.
Discounted Cash Flow Method – The discounted cash flow method takes your expected free cash flows generated in the future by your startup and discounts them to derive a present value (i.e. today’s value)
Other Methods – What the Dave Berkus Valuation Method, the Risk-Factor Summation Method, and the Scorecard Valuation Method share in common is that they use either characteristics (i.e quality management team, sound idea, working prototype, quality board of directors) or risk factors (i.e technology/manufacturing risk, legislation/political risk), or a combination of both, then scale and adjust accordingly depending on the economy and the competitive environment for startup ventures within an industry. In most industries, for pre-revenue startups, the pre-money valuation does not differ too much from one business sector to another.
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