How to value your startup and decide how much equity to give away
13th March 2019
Anthony Rose, Founder & CEO, Seed Legals
Founder & CEO SeedLegals, insight-driven automated legals for startups. Founder Beamly, 6Tribes, QJAM. Investor in Papped. Director Vizrt. The man behind the BBC iPlayer.
Valuing and deciding how much equity to sell of a company that you’ve put your heart and soul into is not easy. While there is no single answer, at SeedLegals we’ve analysed data over hundreds of rounds to help you make an informed decision, and perhaps, more importantly, to be able to justify that valuation to your investors.
Generally when building your pitch deck, you’ll need to make three key decisions:
- How much money should I raise?
- What percentage of the company should I sell?
- What company valuation should I use?
All three questions are mathematically intertwined, so there are two approaches you can take:
- Decide how much money you want to raise, and go forward from there; or
- Start with how much of your company you want to sell, and work backwards.
Option 1: Decide how much money you want to raise
Some advisors say to raise as much as you can. VCs and investors will usually say you should plan to raise enough to last 12-18 months before you need to raise money again.
Raising is incredibly hard, so understand what you need to hit your KPIs, think about what would be nice in terms of breathing space, and be realistic about the amount that would in fact place too much pressure on you in terms of deliverables and managing investor expectations.
The reason for a 12-18 month runway is that realistically you’ll need to be on the fundraising trail six months before you’ll have new money in the bank, and you’ll need to show growth between now and then to get new investors interested. Any shorter than 12 months’ runway and it’s going to be hard to hit key milestones or show any real traction which means you are going to be unable to justify your next round valuation. It’s called a runway for a reason – if you don’t have lift off before you reach the end, things will come to a sudden stop!
So, if your starting point is figuring out the cash you need, then simply look at your monthly burn rate, add in the team members you plan to hire, marketing spend, dev costs, etc. and then look at your monthly burn rate again. Now multiply this by the number of month’s runway you need. Remember to factor in a buffer for the unknown as anything can happen and usually does in startup land!
At this point, it’s important to remember, that although you have used the above as the calculation, funding your monthly burn isn’t the message your investors want to hear. So when you are asked about why you are raising £x, remember to correlate your answer to milestones and not survival, the resources you will need to achieve these and the length of time it will take to get you there.
Option 2: Decide how much of the company you want to sell
As much as Dragons’ Den makes for great TV, here in the real world, equity investment doesn’t work like that.
The general rule of thumb for angel/seed stage rounds is that founders should sell between 10% and 20% of the equity in the company. These parameters weren’t plucked out of thin air, they’re based on what an early equity investor is looking for in terms of return. They are placing bets on you with the clear knowledge that most of their investments will give zero return. They are exposed to a high-risk/high potential scenario, hence will likely want a decent slice of equity to get a meaningful return if things go well, and also to have a meaningful level of influence and control of key company decisions if they don’t.
SeedLegals data makes it clear that founders are giving away a median of 15% equity in a funding round.
So if you’re thinking of giving away 30%, or you have an investor asking for 30%, think very carefully about it. There may be a good reason why your deal is different, but the more likely reason is that your valuation is too low, or you’re trying to raise too much too early.
But, there’s an added twist:
Instead of raising a single larger amount in one go which would carry you for 12–18 months, an increasing number of companies are opting for a series of smaller raises giving away 2% – 6% equity per raise every few months.
In days gone by, this type of raising pattern would have been inadvisable for a few reasons:
- When the founders are always on the founding trail, product and sales can suffer,
- The high cost of legals for each round used to make this an inefficient way to raise money,
- Investors often saw ‘drip feeding’ investment as failure to raise a proper round.
At SeedLegals our goal is to make it fast, easy and efficient for companies to raise money at any time, and to intentionally set up funding rounds with this new flexibility in mind. We want to replace the 12-18 month ‘go big or go bust’ funding cycle into one where founders can raise capital at any time, to meet the company’s needs.
That’s why we launched 2 new ways for UK startups to raise funding in 2018, enabling startups to raise flexibly at any time. We’re proud to now be helping more companies to close funding than any law firm!
So, how should you value your company?
If you were to ask different VCs, they’re likely to come up with a wide variety of responses, including:
- Pitch us a number, if you’re ballsy enough and can justify that valuation based on your product vision, and you and your team’s ability to deliver it, great, we’re in!
- The biggest determinant of your startup’s value are the market forces of the industry and sector in which it plays, which include the balance (or imbalance) between demand and supply of money, the recency and size of recent exits, the willingness for an investor to pay a premium to get into a deal, and the level of desperation of the entrepreneur looking for money. So, basically lots of words to justify a gut feeling.
- Go to Crunchbase, search your nearest competitor, mirror their raise history and take your valuation up or down depending on whether you are pre or post revenue, pre or post launch.
- Multiply the amount you want to raise by 3 or 4 to get the valuation.
Some VCs are led by their head, others by the heart. Either way, there’s no substitute for a data-driven decision, and thanks to available data showing what actually happens across a range of funding round sizes, you’re now well placed to not just come up with a number, but justify it.