How do you measure your company’s growth?
Growth is essential to a startup’s progress, but growth can feel like a totally abstract concept to a company looking for concrete ways to measure their success.
Do you measure your growth by the number of customers using your service? Do you measure it by the amount of revenue taken in over the quarter? These are both decent ways, but in a more general way, you measure the company’s size based on its valuation.
But what is valuation?
Valuation is another way of asking the question “what is this company worth?”
What is the actual dollar amount its stock should sell for?
Startups will usually go through a valuation process when they raise money. Early on, this valuation won’t reflect the actual revenue stream of the company (because there won’t be a real revenue stream to speak of) but will be sort of a made up quantity that a venture fund offers you in exchange for a percentage of your company.
The formula for understanding how raising money in this way works looks something like this:
If the math on this seems a bit daunting, don’t worry; it’s actually pretty simple.
Let’s think about it using some real numbers. If you have a company worth $10 million and a venture fund puts up another $10 million, your valuation is $20 million. So they haven’t taken any portion of your company, but have added to its value by putting money into it. Now, since there are two people putting up equal portions into the company, the venture fund has 50% of the company.
That’s assuming your company is already well along into its development. But to think of how this sort of valuation aids you, let’s think about a company looking for seed money.
You need about $100K to get started and a venture firm puts up that amount, asking for 10%. Running the math backward through our formula, you can say $100K/10% of the company = Valuation at $1 million (in reality, it would be a little higher than that, since your company already has a little money, but for the sake of the thought experiment, let’s assume you’re starting from scratch). In effect, the venture fund has raised your company’s valuation by buying a percentage of the company at a specific amount.
When a venture fund gives you money, how much of your company do they get?
Venture funds normally will ask for about 20-30% of your company when they invest. There’s no great reason why they settled on this amount. Basically, this is what the industry decided over time, and it just kind of stuck.
It may seem like a lot to ask, but really, this helps your company grow (more on this when we talk about dilution in our next video). How much they offer and the percentage they ask for depends a lot on what sector your company is in, the incubator and school it comes out of, and who is doing the investing.
As the company grows, it’ll find other rubrics it can use to find its valuation. Actual revenue flow will be a part of it, for one, but you can also measure valuation based on how many people are using your product, how many new users you have each month, and so on.
Key Takeaways
- Valuation, simply put, is what a company is worth.
- Older companies measure their value from things like revenue streams and users, but for new companies, their value is just tied to whatever funds they can raise at any given time.
- A company’s valuation formula looks like this:
- Valuation = Amount of money you have + amount of money investor gives you / percentage they buy from you
- Venture funds will ask for 20-30% when they give you money. This is for no reason other than it being the industry standard.
Further Resources
- https://angel.co/valuations — This is a great interactive chart with tons of data on how different companies have been valued over the last few years. It includes average valuations from different incubators, colleges, and venture funds, and in different markets.
- Which valuation methods can be used to value a startup? (Quora)
- Paul Graham’s writing on equity.
- Funders and Founders — How Startup Valuation Works
The Startup Fundraising Series:
- What is Equity?
- Why Should You Incorporate Your Startup In Delaware?
- LLC or C-Corporation — Which One Is Right For Startups?
- What are the Different Stages of Startup Fundraising?
- Valuation: How Do You Measure the Growth of Your Company?
- What Are Convertible Notes And Why Use Them?
- Exits: When to Get Out to Stay in the Game
