What the greatest technology investors say about Valuation

No One Gets More Diluted than the Founders

Fred Wilson venture capitalist  and Co-Founder Union Square Ventures

 Wilson discusses employee equity and dilution in technology and high growth businesses.   

“If anyone goes to the pay window, everyone goes to the pay window. [from [] Jeff Minch, [] JLM [] an active commenter on the avc blog].”

“[] If you [] sold [your company] for $100 million and you and your co-founders are gonna make a bunch of money [] you really ought to make sure that every single person who was involved in making that success happen makes a bunch of money too.”

“[] nobody will get more diluted than [the co-founders] because [the co-founders] are there at the very beginning and the dilution will happen over time.  And the person or the investor who shows up at the very end of the process might never get diluted.  The person who was there at the very beginning gets diluted the most.” 

“[] The sooner you can stop talking about equity in percentages and start talking about it in dollars is the sooner that you are going to own more of your company than you would otherwise.” Fred Wilson  April 19, 2012  MBA Mondays Live: Employee Equity - Archive and Feedback- video;

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;

Two Rules of Thumb for Early Stage Fundraising

Fred Wilson venture capitalist and Co-Founder Union Square Ventures

“[With a fast growing company], doubling employees year over year, adding users and customers [] very rapid[ly] [], [] don’t [] raise too much money.  [] [Otherwise] [the company] will be sitting on cash [] raised [at a lower valuation] [] [which is] too dilutive to [founders] and angels.

[Wilson has] two basic rules of thumb [for the amount to raise in early stages, i.e., seed, Series A and B rounds]. First try to dilute in the 10-20% band whenever you raise money.” 10% is preferable.  More may be necessary, “[] but try [] to keep [] dilution below 20% each round.  If you do two or three rounds [exceeding] 20% each round, you’ll end up with too little [equity].

Second, raise 12-18 months of cash each time you raise money.  Less than a year is too little. [] Longer than 18 months means you may [have cash when the company had at a lower valuation].

[] When [a] company gets above 100 employees and valued at north of $50mm, things change. You may need [] more cash [] for working capital [] and [the company] may not be increasing value [as rapidly as] when [it was] smaller.”  A raise of 24+ months cash may then be appropriate.  Fred Wilson, How Much Money To Raise, Jul 3 2011;

Fundraising Terms Pile Up with Later Stage Investors

Mark Suster Partner Upfront Ventures and former entrepreneur

“[] any [early stage terms] will certainly be asked for by future investors in [] later funding rounds so all of these terms pile up [after] 3-4 rounds of funding over a 5 year time frame. And by the time most companies get to an exit [which realistically is still 8-10 years,] often the founders own very little of the economic upside."  Mark Suster, Want to Know How VC’s Calculate Valuation Differently from Founders?  July 22, 2010


Dilution Benchmarks & Fundraising

Mark Suster Partner Upfront Ventures and former entrepreneur

Negotiations between entrepreneurs and investors include dilution and other fundraising terms.  “[] the “fairway” of [investor’s equity] is 25-33% per round [i.e., entrepreneurs’ dilution]. [] If [the entrepreneur is] “super hot” or “super experienced”, [he] can end up with much less dilution –in some cases 12-15%.  But this is the exception, not the rule.”

“[] [These] dilution numbers don't take an option pool into account [].  Options are additional dilution.”

“[] [Valuation can be driven up] ONLY if there’s [] competition [for] a deal.  [Investors stay honest when entrepreneurs] talk with multiple parties.”

Fundraising also requires considering how many future rounds are needed and expected total future dilution.  It’s not an arbitrary spreadsheet-driven exercise reflecting attaining profitability.  It requires “understanding [industry norms necessary] to build a successful Internet business and where [the company falls] on that spectrum given [its business type].”   Mark Suster,  8 Questions to Help Decide if You Should be Raising Money Now, February 17, 2011 and comments;

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;

Do More with Less Before Raising Outside Capital

Brian Garrett Co-Founder and Operating Partner Crosscut Ventures

“[To] increase your chances of success raising capital, it’s do more with less.  It’s get as far as you can on your own dime, on friends and family money [] before [raising] outside capital. That will lead to better valuations [and less dilution]. [] Not every business needs significant capital to hit milestones and be successful. [] [Your] chances of success increase by having hit some really meaningful milestones on your own dime.” Brian Garrett, Seed Capital from Angel Investors: Brian Garrett, Part 10;

Nothing More Dilutive & Morale-Crushing than a Down Round

Chris Dixon General Partner Andreessen Horowitz, angel investor and former entrepreneur

“[] if [an entrepreneur] expect[s] to raise more money (and [he] should expect to), make sure [the] post-money valuation is one that [he’ll] be able to “beat” [exceed] in [the] next round.  There is nothing more dilutive and morale crushing than a down round.” Chris Dixon, Ideal first round funding terms August 16, 2009;

How Much Seed Money to Raise

Chris Dixon General Partner Andreessen Horowitz, angel investor and former entrepreneur

The short answer for how much seed money to raise is “[] enough to get [a] startup to an accretive milestone plus some fudge factor” of say, a 50% round size increase.

““Accretive milestone” [means] getting [a] company [where it] can raise money at a higher valuation” and is a function of market conditions and the startup’s nature.  “As a rule of thumb, [] a successful Series A is one where good VCs invest at a pre-money [valuation] that is at least twice the post-money of the seed round.  So if [a] seed round [] raised $1M at $2M pre ($3M post-money valuation), [] the Series A [] should be [] a minimum of $6M pre (but hopefully [] significantly higher).

The worst thing a seed-stage company can do is raise too little money and only reach part way to a milestone.  Pitching new investors in that case is very hard; often the only way to keep the company alive is to get the existing investors to reinvest at the last round valuation (“reopen the last round”).  The second worst thing [] is rais[ing] too much money in the seed round [], hence taking too much dilution too soon.”

A startup should determine its expected biggest risk and how to eliminate that risk.  “For consumer internet companies [and SMBs (small/medium businesses)], eliminating the biggest risk almost always means getting “traction” – user growth, engagement, etc.[] For online advertising companies you probably want revenues.  If [] selling to enterprises you probably want [] credible beta customers.  

The biggest mistake founders make is thinking that building a product by itself will be perceived as an accretive milestone.  Building a product is only accretive [] where there is significant technical risk []”.   Chris Dixon What’s the right amount of seed money to raise?  Dec. 28, 2009;