

Ask YC: I'm pitching to an angel. How do I value my startup? - hacker64

I have a meeting with an angel investor soon and he wants to know at what valuation I'm asking him to get in. I guess this is the pre-money valuation. My startup has two people, both programmers, and we've been working on it for 6 months now. We have a web site online and it's starting to grow, but it's not big by any means, although the potential could be huge.<p>Any advice, resources, or tips on how to come up with the right valuation? Should I ask for a very high number and be willing to negotiate down? Or should I set a value and stick with it? Thanks everyone.
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iamelgringo
[disclaimer]Mind you, I'm on the outside looking in. I really haven't started
the startup funding shuffle yet, but I've read compulsively. And, this is what
I've gleaned. YMMV.[/disclaimer]

First, a few important questions.

Do you have revenue? How many users? How fast have your been growing?
Proprietary patentable technology, or a user focused tool built on open
source? I'd say that how many people are on the team, and how long you've been
coding is rather unimportant. What is most important is what you have in hand.

What is a startup worth? Ultimately what the market is willing to pay for it.
So, it's worth whatever you're willing to sell a stake of it for, and whatever
the angel is willing to buy a stake for. It all depends where the investors
and the market are at in the greed <\--> fear continuum. Right now, I get the
impression that we're towards the end of the greed spectrum, and we'll be
swinging back to fear soon. I know that's not very helpful, but ultimately
it's all voodoo and people's best guesses. But, there are a few guidelines.

It helps to have a base case. Take for example YC funded companies:

Y Combinator offers $5,000 n + $5,000 where n is the number of founders for a
5-20% stake in a startup. That's usually for a group of founders with an idea,
a prototype or maybe a little bit of code and a few users. That means that 0-6
months ago, had you been funded by YC, here's what your company would have
been worth:

$5,000 x 2 founders + $5,000 = $15,000 for a 5-20% stake in your company. If
$15,000 is worth 5-20% of your company, that means that your company was worth
$75,000 to $300,000. Here's the formula:

startup value = investment/stake

or in the above YC case:

value = $15000/5% = $75000 at the low end

or

value = $15000/20% = $300,000 at the high end

Does this make sense? Someone please correct me if I'm wrong, but this is
pretty much how I understand it's done.

If you have more traction than a typical YC group, i.e. more users, unique
technology, revenue streams, strong code base, etc... Then, you're probably
worth more than the $75,000 - $300,000 valuation. If you have more traction,
you're probably looking at a 300,000 - 1,000,000 valuation. If you have less
or as much traction, you're looking at the YC range.

Anybody else have any thoughts on the matter?

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brett
I think you mean:

value = $15000/20% = $75000 at the low end

or

value = $15000/5% = $300,000 at the high end

~~~
iamelgringo
:) Yeah. I was tired when I wrote the post. Thanks.

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freikwcs
Often the usual response is something similar to "we are anxious to go through
a formal valuation process should we determine this is an appropriate possible
investment." It's certainly a bit of a chicken answer, but you can provide
numbers such as revenue, product developments, and users to give an idea of
what a proper valuation would be. The idea is to not price yourself out of
their range during the first conversation.

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lisper
You might want to consider punting on the question altogether by taking angel
money as convertible debt instead of equity.

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car
I agree. Convertible debt financing delays the valuation question until it
becomes reasonable and is a common way to do seed rounds.

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mattmaroon
Don't. Say something like "I want to keep x% of the company". Thus if you end
up getting more funding than you initially expected (happens often) you'll
essentially get a higher val.

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hacker64
That's an interesting twist. Thanks. Is it common?

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skmurphy
It may be common but the more important question the investor will have is how
soon and for how much you can sell the company (in other words how will you
use the funds to create more value / reduce risk in the startup). There will
be other terms associated with a funding that will have a significant impact
on how much you make when you sell (for a reasonable range of exits). A couple
of good sites for background on funding:

<http://venturehacks.com/>

<http://www.feld.com/blog/archives/cat_term_sheet.html>

<http://www.startupcompanylawyer.com/?s=term+sheet>

<http://www.paulgraham.com/guidetoinvestors.html>

[http://www.skmurphy.com/blog/2007/12/01/three-points-
about-s...](http://www.skmurphy.com/blog/2007/12/01/three-points-about-
seeking-investment/)

~~~
mattmaroon
No investor ever asks you "how soon and for how much can you sell the
company." Ever. And if they do, go elsewhere.

~~~
skmurphy
you're right, what I should have written is the question in their mind is "how
soon and for how much can we create liquidity" with more of a focus on how
much than how soon. In other words, how will the funds be used to reduce the
risk in the startup. If acquisition is your likely exit (and that's a safe bet
for most new startups) then they may ask you to speculate who would buy the
firm and for how much. I am not advocating a "built to flip" strategy" as much
as trying to understand an investor perspective.

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skmurphy
Don't get locked on the pre-money valuation: the other terms tend to have a
much bigger impact on how much you actually make.

What's your plan for paying the investor back? Will you need a follow on
round? How much, when, and why. What risks about your startup will you have
reduced before you need to raise another round. Can you be acquired based on
what you will achieve with this first round.

Have you talked to other teams this investor has worked with? You have to
assign a value to the expertise, advice, and connections that this investor
will bring. Most angel investors supply more than money. That's one of the
reasons teams want to take money from Ycombinator, they have a well defined
methodology and a constellation of other folks they can connect you with who
can help you succeed.

You are negotiating the start of a relationship that will normally only end
when your firm goes bankrupt or is sold: this is not a transaction this is a
long term partnership.

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rms
How much money are you trying to raise?

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hacker64
We have a low burn rate, so a $100K should be enough to allow the two of us to
continue working on it for another year, including a small marketing budget,
and occasionally bringing in a consultant for the things we need help with
(graphics, marketing consultations, legal, ..etc).

~~~
mattmaroon
I'd also shoot for more than a year's expenses. I've found investors like to
hear you're aiming for 18-24 months. Consider that you have to essentially
start seeking funding 6 months before running dry. If you aim for 1 year's
expenses you work 6 months, then start on fundraising. Raise 18 months'
expenses and you work for 12 before fundraising again, so you get double the
progress for only 50% more money.

And if you can raise $100k, you can almost certainly raise 150.

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mig
$100K is not enough to sustain two employees for an year. $50K is less than
the annual average living expenses for a person. (Just do the Math, housing,
insurance, etc.). I would strongggggggggly recommend to try raising something
between 0.75M an 1M. I have noticed a lot of fellow hackers seriously
undervaluing the time they spend building a product. Two strong hackers,
working for 6 months is eaily $140K expenses(and I am including just the
salary an employer would pay). Please, please do not undervalue your time and
expertise.

With the oncoming recession and all, you do want to have enough in the bank
for at least 1 to 2 years, if you are serious about your startup.

~~~
jamiequint
$100k is more than enough to sustain two founders for a year. Especially if
the founders happen to be young and unmarried. If they were living together
they could probably make it on expenses of $50k for a year while still living
relatively comfortably (even at Silicon Valley prices).

Also, I'm not sure what to make of your comment "Two strong hackers, working
for 6 months is eaily $140K expenses" How good the hackers is hardly related
to the expenses they require. Perhaps 140k is the opportunity cost?

Having enough in the bank for 1-2 years is probably a good idea, but it sounds
like they could do that on $250k-$350k.

Also, I agree with matt, focus on the percentage you are giving away rather
than the amount you want to take.

~~~
bayareaguy
At $50K your taxes are going to be pretty low, but just the same try and have
the company pay for things instead of buying them with your salary.

If you look around you may find a business partner who could give you some
money as part of some kind of deal. Traditional software companies can do this
by pre-selling licenses at a discount and web companies looking for ways to
get more users may pay you if you find a way to help your users get signed up
with them. However I'd caution against spending too much time on this sort of
thing yourself as it can easily become a distraction.

