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First round valuations

I get quite a few questions sent in by readers and am going to make more of an effort to post some of the ones that I think would be of general interest (please – keep them coming). Recently Jonathan asked: Do you have any reference regarding recent pre seed, seed, and first round valuations for B2C companies? We had several back and forth e-mails about this over the past week and I thought they were worth summarizing here. First, some additional background from a subsequent e-mail from Jonathan: I am actually doing two simultaneous rounds: one for 125K and another for 1.4 million. The first one aims at testing the viral potential of the application. We will focus on improving our site, doing PR and furthering our relationship with bloggers in the field. The distinctive aim of the second – 1.4M – round is to do conventional online advertising. The idea is that if our 122K round is successful (meaning we acquire users at a very cheap rate and manage generate some income early on) we can improve our barging power for the 1.4 M round or skip it altogether and take it to the next level. The main problem with this process is in the valuation. Here was my response: Classically in this type of situation you’d probably try to structure the first $125k as a bridge that converts into the next preferred round at a slight discount (from 10-20% depending on risk and timing of the second round).  That way you essentially punt the value conversation until later and if you execute well on the first set of money you get the benefit of your stellar execution in the form of less dilution when you put together the big round (and at the end of the day from your perspective this is all about getting money into the business so you end up with as much of your company as possible). HOWEVER, if the money for both rounds is coming from the same set of investors, you need to be careful here because they’ll have the ability to foreclose on the business because of the debt structure of the financing instrument in this case.  If that’s the case, I’d look at trying to roll this together into a single round that is traunched based on your hitting milestones (so the first $125k funds at closing but the $1.4m doesn’t fund until you hit some level of traffic or something like that).  You’ll have to have the valuation conversation up front in that case, but the benefit is that you’ll have a deal for $1.525m instead of just $125k.  As for valuation, it varies a lot depending on the type of investor you are bringing in, the amount of money you are raising and the region of the country in which you are located. If you were just raising a $125k angel round, you pre-money value would be ~ $1.5m – $2m.  If you raise $1.5m you could probably push that a bit – maybe to $3m.  First round venture deals (true institutional Series A – product with some interest, but not yet generating any real revenue) are generally in the $5m range.  BtoC is in favor again, so there’s some room to push your valuation based on market interest, but that’s likely for your next round and based on strong execution (and lots of subscribers).

August 22nd, 2006     Categories: Venture Economics    
  • Scott G

    Any suggestions on method(s) that you have used for valuations of pre-revenue commpanies? Or does it just come down to how much of this company do we need to own in order to get the return we need?
    I have provided a couple of methods that were past on from another VC firm.
    1) Discount from the expected sale price. We use a 10X hurdle and assume at least one more round of financing. For example, if we feel the company could be sold for $65 million (which is the median sale price of a software company), we would discount the premoney to $6.5 million and then some further price reduction for dilution say 40%. This gives us a pre-money of $3.9 million.
    2) 1X – 3X next year’s revenue. This normally is about $2 – $5 million.
    3) Essentially, we use the above two examples and then say it going to be below $5 million. How far below depends on how much capital they need. Normally the best case is 50% of the company. Worst case is 20% of the company. Anything within that range is fine assuming it doesn’t violate the above two rules by a large amount.
    Thanks,
    Scott