Valuation Returns-Formulas-Rules of Thumb

What the greatest technology investors say about Valuation Returns-Formulas-Rules of Thumb

An Option Pool is about Price

Fred Wilson venture capitalist and Co-Founder Union Square Ventures

“One [] contentious [] negotiation [point] between an entrepreneur and a VC [], particularly [in] an early stage financing, is the inclusion of an option pool in the pre-money valuation. [] [The] fact [is an option pool] is simply about price.  [Example]:  [] $3.25mm pre-money with no option pool [can be equivalent to] $4mm pre-money with one. [] What an entrepreneur needs to do is find out what the market price for [his] company is with and without an option pool in the number. [Then], the negotiation over this point is [] less contentious.”

“[] [Wilson acknowledges that if] options are counted in the pre-money, entrepreneurs will want commensurately higher valuations to compensate for the additional dilution.”

“[][The] option pool request needs to be reasonable and based on [a] budget.  [Wilson looks for] enough options [in] the "pre-money pool" to fund the hiring and retention needs [] until the next financing.”  Wilson wants an option pool in the pre-money when he invests.  Fred Wilson, Valuation and Option Pool and comments, Nov. 6, 2009;  http://www.avc.com/a_vc/2009/11/valuation-and-option-pool.html#comment-22043449

Be Leary of Too High a Price

Mark Suster Partner Upfront Ventures and former entrepreneur

 “[] [Suster has] seen a destructive cycle where otherwise interesting companies have been screwed by raising too much money at too high of prices and gotten [] [trapped] when [] markets correct and they got ahead of themselves [on inherent market valuation]. []

[It’s] OK to [] shoot for the “top end of normal” for the market conditions. [] [He] caution[s] entrepreneurs from [] raising money at significantly ABOVE market valuations. []

If [entrepreneurs] haven’t figured out product / market fit and therefore still have a highly risky business [they] run great risks for getting too far ahead [] on valuation. [] [Most] investors won’t want to [][do] a “down round,” which creates tension between them and early investors.

[] [Sophisticated] investors know [a major down round] is fool’s gold.  They get a cheaper price, [] wipe out much founder stock value and [] reissue [founders] new options. [Founders] take the money []” except their incentives get eliminated.

[] He advises “[] us[ing] competition to [][ensure] a fair price [and] rais[ing] a slightly higher round than [] [otherwise for some strategic reserve]. [] [One wants] to show an uptick in valuation [] for new investor confidence and to maintain [early investor relations].”  Mark Suster  Why Startups Should Raise Money at the Top End of Normal,  June 5, 2011;  http://www.bothsidesofthetable.com/2011/06/05/why-startups-should-raise-money-at-the-top-end-of-normal/

 

When Can You Sell?

Basil Peters angel investor and Principal Strategic Exits Corporation

“When can [one] sell? [] [With] M&A [merger & acquisition] exits [] the real threshold is to ‘prove the business model’. [To prove the model] [] a recurring revenue business [] [should show] actual results for: revenue per customer, gross margin per customer, customer lifetime (or churn [i.e., how long one enjoys that customer]) [and] cost of customer acquisition.  In other words, how much is a customer worth and what do[es] [a customer] cost to acquire?

[With that proven model], [] credible projection[s] [can be built] that [show] if: new owners added $X millions of capital, the business would have Y customers and be worth $Z millions.

That’s when [one] can sell [although] there are often additional factors like competitors and market changes. [] As soon as [one] prove[s] the model is often the best time to sell.  [It’s] always best to sell on an upward trend. Sell[ing] on the promise, not the reality [is] often when [one] [gets] the best price.”   Basil Peters, Maximizing Exit Value Angel Capital Assn Annual Summit Workshop Apr. 15, 2009;  http://www.basilpeters.com/Presentations/Maximizing_Exit_Value_20090415_Part_2.pdf , pg 5-10

 

Angels Need a 20-25%/yr Return

Basil Peters angel investor and Principal Strategic Exits Corporation

“[] angels need to get 20% to 25% per year [] the same [return] as a venture fund.  So, if you do the math, [] angels need to make three to five times their money in three to five years.”    Basil Peters, Seed Capital From Angel Investors: Basil Peters, CEO and Fund Manager, Fundamental Technologies II (Part 5);  Jul 7, 2010;  http://www.sramanamitra.com/2010/07/07/seed-capital-from-angel-investors-basil-peters-ceo-and-fund-manager-fundamental-technologies-ii-part-5/

Why VC's Block an Exit

Basil Peters angel investor and Principal Strategic Exits Corporation

“Most entrepreneurs don’t even know that a VC is likely to block an exit when they accept the VC’s money. [] VCs design their investment agreements to give them the power to block exits.”

“[] VCs will almost always block a sale where they only make a 3-4X return on their investment.  This could have easily been a 10X return for the angels and a 100X return for the entrepreneurs.

[] The winners [must] produce at least 10-30X return for the [VC] fund to perform respectably.

[] This propensity to block exits is one of the reasons that every company needs a clear exit strategy before [it approaches its] first investor.”  Basil Peters, How VCs Block Exits, August 28, 2010, http://www.exits.com/blog/how-vcs-block-exits/; Why VCs Will Block Good Exits;  http://www.angelblog.net/Why_VCs_Block_Good_Exits.html

High Valuations Can Limit Exit Opportunities

Josh Kopelman Partner First Round Capital and former entrepreneur

Kopelman advises that entrepreneurs who “[] try to maximize valuation [] in many cases [] might be shortsighted” because high valuations can limit exit opportunities.  “[] too many founders are not aware that they are shutting off the majority of exits -- and therefore increasing risks -- when they accept a high valuation.”  “[] the “unwritten term in the term sheet” [means] few VC’s will willingly part with a “winning company” (i.e., a company that is executing/performing well) for less than a 10x return.”  Thus, a VC could block an exit that could have been a fabulous payout for entrepreneurs and angels.   Josh Kopelman The Unintentional Moonshot, July 10, 2007, http://redeye.firstround.com/2007/07/the-unintention.html;  When the music stops... March 10, 2006;  http://redeye.firstround.com/2006/03/as_a_little_kid.html

The Unwritten Term on the Term Sheet

Josh Kopelman Partner First Round Capital and former entrepreneur

 “When a company gets a term sheet with a high valuation, [the entrepreneur] need[s] to pay attention to the unwritten term on the term sheet.”  The entrepreneur should be ok “with [an] exit multiple that would generate [] returns [] to satisfy [] VC[‘s]. While every situation is unique, here's a simple rule of thumb:

Series A – 10X
Series B – 4-7X
Series C – 2-4X ”

“[] the “unwritten term in the term sheet” [means] few VC’s will willingly part with a “winning company” (i.e., a company that is executing/performing well) for less than a 10x return.”  Josh Kopelman The Unintentional Moonshot, July 10, 2007, http://redeye.firstround.com/2007/07/the-unintention.html; file Josh Kopelman Unintent Moonst Unwrt;      http://redeye.firstround.com/2006/03/as_a_little_kid.html

Early Stage Investing is Far from an Exact Science

Boston Millennia Partners venture capital firm

“Early stage investing is far from an exact science.  Early-stage companies are often comprised of little more than an entrepreneur with an idea. Valuations at the “seed stage” are generally driven by factors that by their nature are subjective. These include appraisals of the CEO and management team, novelty of the value proposition, evaluation of intellectual property, expected time-to-market, expected path to profitability, estimated capital needs and burn rate, syndicate risk, sector volatility and deal structure.  In post-seed investing, intermediate data points such as events demonstrating proof of principle and product validation will factor strongly in valuation determinations.   As a company matures to a revenue stage, more quantifiable data is produced in the form of operating statistics and performance indicators.  Actual results allow investors to more accurately model [] revenue, EBITDA, cash burn, pipeline close rates, backlog, bookings and enterprise valuation.”   A. Dana Callow, Jr. Managing General Partner, Boston Millennia Partners, Michael Larsen, Senior Associate, Life Sciences; paper called Understanding Valuation: A Venture Investor’s Perspective; http://www.millenniapartners.com/_documents/whitepaper/WhitePaperAttachment6.pdf