Editor’s Note: Each week, Fast Company presents an advice column by Maynard Webb, former CEO of LiveOps and the former COO of eBay. Webb offers candid, practical, and sometimes surprising advice to entrepreneurs and founders. To submit a question, write to Webb at email@example.com.
Q: I’m creating an app and bootstrapping the development, but I’d like to raise money so I can market it. I have some interest from an investor and he’s introducing me to other investors, but I have no idea how to set a valuation. We haven’t even launched—how am I supposed to know what it’s worth? And, what’s the right percentage to give up?
—First-time founder of a consumer app in the dating space
I understand why you’re confused. Setting valuation for a startup is kind of like trying to figure out the odds of the Super Bowl before the game is played. In this case, the winners and losers don’t go home after the game is over; investors and entrepreneurs will be working together for many years.
You have to determine what the company—your idea and team—is really worth. Solicit a couple of friendly sources for their feedback on what the market is currently paying to invest in a company like yours. This answer can vary with time, your revenue, your sector, or recent news about you or competitors. We worked with one startup that easily was able to raise up to their series B—until Google entered their market and offered their services for free. And trends change—in 2013, it was easy to raise a round with a deck that started with “Uber for X,” where X could be laundry, alcohol, even furniture. Try that today, and VCs probably won’t respond.
Of course, you want the maximum valuation for your company, but it’s important to take a long-term perspective. It might seem like you won if the deal is overpriced and you gave up less of your company, but, in reality, that comes with the price of an investor with a board seat who’s steaming about overpaying for an overvalued deal.
We once met with founders who had raised on slightly aggressive terms, in part because of how aggressive their financial projections were. When they failed to meet expectations, they had thought it would be okay, as their projections were “pitch deck metrics,” which everyone knows to discount. Their new board member was less forgiving, however, and now believed that he had overpaid for the investment, which yielded a difficult dynamic in the boardroom.
Some things to think about:
When do you need to raise money? Timing matters. Raising money with more progress is better as long as you have enough cash. It’s always better to raise in a position of strength, not weakness. People see when you are desperate. Raising money is like accessing credit—really easy to get when you don’t need it and really difficult when you do. Also, remember, there are a lot of things beyond your control. In early to mid-2008 companies saw good valuations, but months later the world melted and they would not have been able to get the same valuation—if they could have raised money at all.
How much should you raise? Well, how much money do you need? In some ways, startups need less money today than they used to, but you need to raise enough so that you are not constantly raising money. We recommend modeling 18 to 24 months of runway (the longer the runway, the better, as things will usually take longer than you expect).
With all of this in mind, companies can start thinking about dilution. Typically, we see companies give away somewhere between 15% and 25% of their company for most rounds of funding, with smaller percentages as companies get later stage and have more options. Try to give away enough to be worth great investors’ time and attention, but not so much that you lose control of the business long-term.
Lastly, remember valuation is not the only term that matters. One time I saw a term sheet from an investor that demanded three different board seats—for a seed round. I coached the founder to back away as fast as possible. Term sheets can include provisions about number of board seats, observer seats, rules for handling debt, how a CEO can be dismissed, and more. Ask your friends for horror stories, and always ask a lawyer to read your docs before signing (and read them yourself, too). Conversely, you may want to take a lower valuation, provided that it results in the best possible board member for your business.
In general, optimize for people first. You’ll be with your investors a long time, and what valuation you got in what round will almost never matter as much as how much integrity you had at all stages. Don’t give away excessive amounts, but if you can think abundantly and focus on making the pie bigger for everyone, this process will be easier and more pleasant.