Looking for investment when your startup is still in its early days can feel a little baffling. You have no product, no marketing, no IP - so it’s impossible to know how much your shares are worth. How do you set a valuation for a business that’s still only an idea?
The most important step is letting go of the idea that the valuation matters. Yes, you need a number to put on the term sheet, but investors will understand that this figure is mostly meaningless until you test your idea in the marketplace. Instead, figure out what a year of runway will cost, then set a valuation that lets you raise that much money.
Then you can negotiate with VCs based on how much of your company you’re willing to give up. Seed-stage investors know that they’re gambling on the strength of your idea, so you just need to find out how much it’s worth to them to be dealt in.
Many startup founders agonize over this question, even though it’s often pretty simple to answer.
Do you have:
Unless the answer to any of these questions is “Yes”, your company is effectively worth nothing.
That sounds harsh, but the truth is that it’s basically impossible to quantify the worth of an idea until someone - either a customer or an investor - offers to pay something for it.
No matter what valuation you settle on in your seed round, it’s virtually guaranteed to change once you get a product built and see how much traction you get in the market.
This uncertainty can be paralyzing for new founders, who wind up spending way too much time obsessing over how to set their valuation. They worry that they’ll set it too high to get any investors, or so low that they’ll cheat themselves.
But it doesn’t matter what the idea is “really” worth if you can’t raise enough capital to make it a reality.
There’s no such thing as “too high” or “too low” yet, because there’s no actual value to serve as a benchmark. Let go of that anxiety and ask for as much as you need.
The best way to work out your early-stage valuation is by starting with the actual dollar amount you need to raise.
Put all of that together, and you’ve got a target number to shoot for.
Then figure out how much equity in the company you’re willing to concede. This can vary a little bit from startup to startup, but don’t give up more than 20-30% ownership - lower if possible. Ultimately, you’re aiming to keep it as low as you can.
Decide the maximum amount you’re willing to give up. Then pick an initial offer that’s lower than that - say 10-15%.
And just like that, you have a valuation for your company - whatever number lets you raise the runway you need by selling 10-15%.
When you bring this figure to investors, you can be up-front about how you arrived at it.
A VC who knows what they’re doing will understand that any valuation at this stage is a shot in the dark, and they’ll treat your number as what it is: a starting point for negotiation.
You don’t have hard numbers to show yet, so don’t try to pretend that your valuation is definitive. Instead, you need to convince your investors to back you based on your idea, your passion, and the clarity of your vision.
They’ll trust you more if you’re straightforward and realistic about the current value of your business.
When you tally up what you’ll need to get your startup off the ground, you might come up with a pretty daunting number. You might wonder if you can really ask your investors for that much on the strength of your idea alone.
In the best-case scenario, you’d be starting out with a solid 15-18 months of runway. And it’s worth at least shooting for that at first.
You might be surprised at what investors are willing to offer!
But if you can’t find any takers at that price, you can often strike a more limited deal in which you start by only asking for enough to get the product built.
You’re sticking with the same valuation, but you’re not asking investors to pay your salaries and fund a full-scale marketing campaign. Instead, you offer just enough equity to cover your development costs - with the understanding that you’ll ask for more later.
This means you’ll have to work on a shoestring budget for a while, taking on the initial sales and marketing costs yourself.
Then, once you’ve actually created the product and acquired your first five or ten customers, you go back to your investors and ask them to buy in more at the same valuation.
Now you have something tangible to show them. They can see the product and the business strategy in action. And you can make a much better case for your company’s worth.
Investors who understand the startup life cycle know that once you’ve cleared the gap between 0 customers and 1, your business is a lot more viable. They’ll often be more attracted to this kind of deal than to a request to pave your entire runway up front.
Don’t get hung up on trying to come up with a realistic valuation before your idea has been tested in the market. Any number you come up with now barely qualifies as an educated guess.
Instead, stay focused on what it will take to get your business through its launch.
If you can make your investors believe in your idea, they’ll give you what you need to bring it to life.