Here I am on my soapbox about why you should not anchor on valuations reported in tech news. 😜
That’s from Main Street Fund Demo Day where I was reminded of two very helpful, back-of-the-napkin fundraising formulas, thanks to the talented founders and thoughtful questions!
Simple.
Obvious (once you know them).
With math that even my 8 year old can do.
These are not hard-and-fast rules but they are a helpful starting place to think about valuations and future growth.
Here are 2 “cheat codes” every founder should know before they raise capital!
Valuation 101
Quick review on valuations before we start.
Valuations are driven by:
Revenue, traction
Growth rate
Company stage
Industry
What the public markets are doing
How competitive the deal is (multiple interested parties bidding up the price)
Market comps (what happened with other companies like yours)
The story you tell/what investors believe about the upside
A firm’s unique thesis (e.g. Tiger Global circa 2021 offered high valuations as a sales point, PE firms are typically price sensitive while strategics are less so)
Specific terms of a deal (e.g. higher valuation but more downside protection for investors)
And a bunch of other stuff
Here’s a deep dive if you want more!
You may hear that it’s more art than science. There’s a lot of different factors that vary in importance depending on the firm and the deal.
So that’s what’s happening at a high level. Some factors are within your control, some are not.
Now, the simple venture math that investors know — and you should too!
[Formula #1] 5x Implied Valuation
Implied valuation: The amount you raise signals your valuation, whether you say it aloud or not.
If you’re a first-time fundraiser, you may not understand this:
That the amount you are raising is a key signal to investors.
The baseline is 20% dilution. Put another way — a company valuation of 5x the amount being raised.
Investors expect their investment to result in 10-25% ownership after the round, depending on the deal. So there is negotiation and it’s not set in stone. But it is identifying a valuation range.
It’s similar to identifying a job title in the interview process. There’s still a salary range and negotiation. But “CMO” signals something different than “Marketing Manager.”
Let’s look at some numbers…
Example: Startup Raising $250k
10% dilution = investor will own 10% = 10 * <amt raised> = $2.5M valuation
20% dilution = 5 * 250k = $1.25M valuation
25% dilution = 4 * 250k = $1M valuation
Example: Startup Raising $1M
10% dilution = investor will own 10% = 10 * <amt raised> = $10M valuation
20% dilution = 5 * $1M = $5M valuation
25% dilution = 4* $1M = $4M valuation
The Punchline
It’s important to understand what you’re signaling to investors!
Yes, there’s still a range of valuations and everyone will negotiate.
But you can’t raise $100k at a $20M valuation. Or $5M at a $6M valuation.
(I mean, you can. I’m sure someone has done it. But we’re talking norms here.)
Once a valuation is agreed upon, you can take more or less money to impact dilution (possibly — some firms have a minimum investment).
You can also say you have a range of what you are raising (e.g. $1-2M) This gets a little tricky because investors want to know how you are going to use the money and you have to have multiple financial models. But basically, you just grow faster.
The other reason most founders put the amount they are raising but not a specific valuation (even though it is implied) is Negotiation 101! Never throw out the first number. 😉
You don’t want to anchor too hard or scare someone off by saying a number too early. There’s still a range of valuations (4x-10x) within that raise amount.
[Formula #2] 2x Valuation Every Round
2x Valuation: Each future round ideally doubles the last, so you need to plan for the next one before you close this one.
When a company is raising a funding round and wants to understand the implications of future fundraising and dilution, here is the simple math:
What is your ideal valuation next round?
Double the valuation from this round!
Example:
This round = $5M valuation
Next round = $10M valuation
Next next round = $20M valuation
Why does that matter?!?!
Your valuation this round leads to implied revenue and growth numbers for future rounds.
Work backwards to understand your growth targets:
Next round = 2x this round’s valuation
What does growth rate and revenue need to look like get that valuation?
Can I hit those growth and revenue numbers?
Can I get there with the current funding?
✅ If YES → proceed to world domination!
❌ If NO → revisit your financial model and overall growth plan.
Do you need more capital now?
Is your valuation too high?
Do you need more efficiencies or better growth/leverage somewhere?
Example (high valuation + downstream effects):
This round = $50M valuation → omg, yay. I’m amazing
Next round = $100M valuation → ok, gonna need $1-10M revenue to get this valuation…uh oh, took longer than we thought. Only 250k revenue 😬
Next next round = $200M valuation → Need $10-20M in revenue. Gulp. 🥴
This isn’t the end of the world! You don’t have to 2x valuation. But it’s a good point of reference to understand what the best companies are doing and long term implications.
The Punchline
It’s tempting to get the highest valuation possible. Less dilution, big market signal, fun reward for a founder’s effort.
But there’s downstream effects.
The bar for growth is very, very high.
No wiggle room for unexpected growing pains, hiring missteps, or economic speed bumps.
You may have trouble raising or receive a less favorable valuation in the future even though the company is doing good (but not great).
It’s always a balancing act!
Negotiate the best deal possible while still setting yourself up for future success.
Know Before You Go (To Fundraise)
There’s no perfect valuation — higher or lower has tradeoffs — and the future is unknown.
The economy could be booming, there could be a pandemic, or we could have both at the same time! (Random example.)
Every fundraising deal will have its own unique circumstances and there’s exceptions to every rule.
These formulas are not set in stone (have I given enough disclaimers??) but it’s helpful to have a high-level framework to know how investors may be thinking about deals and valuations. No spreadsheet required!
Any favorite valuation frameworks or tips? What surprised you most about fundraising?
(P.S. If you’re thinking about fundraising or want more info on valuation, feel free to shoot me a note or join our Office Hours this month!)
You say one can't raise $100k at a $20M valuation while leaving room for exceptions. This makes me question my strategy. My team won an SBIR award from the National Science Foundation. For anyone unfamiliar with SBIR, it's a non-dilutive grant awarded to commercialize deep tech innovations. We are strong contenders to get the Phase 2 award early next year, which is worth up to $1.25M. Once we get the award, the NSF will match 50% of any VC money raised up to an additional $500k. So we want to raise only a small amount now to fund ourselves during the application review process.
Is roughly 5% dilution something an investor won't normally consider? I would think in this case, having the backing of the grant would reduce the risk for the VC, but perhaps 5% is too small of a stake... I would like to know your thoughts or the thoughts of anyone else who might see this. Thanks.