Fundability and Valuation of Startups: An Angel's Perspective
William H. (Bill) Payne, Senior Program Consultant, Kauffman Foundation
During a round of investment in seed- (startup) and early-stage companies¹, angel investors typically invest from $25,000 to $100,000 each. The round usually totals between $250,000 and $1 million, and the company valuations run from $1 million to $3 million. Collectively, the angels purchase from 20 to 40 percent of a company's equity and seek a return of 20-30x over five years. These anticipated returns are reasonable, considering the risk in such ventures and the impact of dilution by subsequent investors.
Since the Internet bubble burst, the pre-money valuations² of seed-stage companies by venture capitalists have averaged between $1 million and $3 million³. Angel investors tend to participate at earlier investment stages than venture capitalists, so pre-money valuations for angel deals nearly always fall into this admittedly wide range. What factors within this range impact the valuation of a specific company
Factors Impacting the Valuation
The accompanying Valuation Worksheet provides entrepreneurs and investors with an empirical basis for deciding if a startup company should be valued near the top or bottom of the range. It's not designed to be used for definitive valuation calculations.
The Valuation Worksheet lists major factors and key issues to consider in judging the value of a seed/startup company. Note the following features:
- The major factors are listed roughly in order of importance.
- Each major factor has been assigned a weighted ranking. For example, the "Strength of the Management Team" is worth 30 percent while "Sales Channels" are worth 10 percent. Investors put greater emphasis on the management team and the size of the opportunity than they do other factors.
- Within each major factor, the impact of each issue has been assigned a valuation ranking from +++ (very positive) to - - - (very negative) to assist the investor decide the overall weighted ranking to be assigned to the valuation. Some factors, such as the size of the opportunity (scalability) and coachability of the entrepreneur, can be deal killers.
No two investors will value a company the same. With practice, however, investors can use this worksheet to compare companies and determine whether valuation should be near the high or low end of a reasonable range.
Entrepreneurs can use the worksheet to gain insights into what investors are looking for in a fundable seed-stage company and to identify factors that justify higher pre-money valuations. The worksheet is also a roadmap on how entrepreneurs can improve the fundability of their enterprises and increase the pre-money valuation.
Keep in mind that this worksheet is only a guide. In the end, valuation of pre-revenue startup companies is an art.
The Last Word
There is no universally accepted analytical methodology for assigning value to a pre-revenue, startup company. Nonetheless, investors and entrepreneurs negotiate the value of tens of thousands of such ventures annually. In general, the factors and issues described in the worksheet are used by investors to: 1) determine the range of valuations appropriate for individual companies; and 2) identify specific factors and issues that determine at which end of those ranges individual companies should be valued.
1 PricewaterhouseCoopers' MoneyTree™ provides the following definitions:
- Seed/Startup Stage: The initial stage. The company has a concept or product under development but is probably not fully operational. Usually in existence less than eighteen months.
- Early Stage: The company has a product or service in testing or pilot production. In some cases, the product may be commercially available. May or may not be generating revenues. Usually in business less than three years.
2 See the extended discussion of pre-money valuation in "Valuation of Pre-revenue Companies: The Venture Capital Method" by William H. (Bill) Payne in eVenturing's Collection titled "Valuing Pre-revenue Companies."
3 "Is Valuation a Key Issue in Funding Startups?," by George Lipper, July 2007. This article is also included in eVenturing's Collection titled "Valuing Pre-revenue Companies."
© 2007 Ewing Marion Kauffman Foundation. All rights reserved.