How Startup Valuation Works — Illustrated

Author: Anna Vital (Funders and Founders) · Published: July 1, 2013 · URL: http://fundersandfounders.com/how-startup-valuation-works/ [STALE — checked 2026-09-16: the site is gone; archived from the Wayback Machine capture of 2016-11-23]

One-line: An infographic and explainer for founders: an early-stage valuation doesn’t show what the company is worth, only how much of it an investor gets for the money. It is set by how much you need and who you take it from, then by revenue multiples as the company grows, and finally by the tug between present revenue and the promise of growth at exit.

Summary

Funders and Founders was Anna Vital’s infographic site for entrepreneurs. The post pairs a tall infographic with an essay, organized by stage.

Early stage: valuation is a share price, not a worth. The infographic’s first line is that at the early stages “valuation does not show the true value of the company. It shows how much of the company investor gets for his investment.” The essay puts it concretely: raise $100,000 for 10 percent and your pre-money valuation is $1 million, though “you probably could not sell it for that amount.” Her method is to work backward from the amount you need. First set the raise at the minimum that gets you to visible growth and the next round (the infographic says enough for three experiments plus at least six months of runway, with investors wanting growth inside 18 months). Then set the stake: never more than 50 percent, since the founder would lose incentive, and not 40 percent either, since that starves the next round. For a small seed, 5 to 20 percent is normal, which puts a $100,000 raise between a $500,000 and a $2 million pre-money valuation. Where it lands in that range depends on how investors value comparable companies and how convincingly you show fast growth.

The infographic adds 2012 averages by type of investor: incubator about $20K at $400K (5 percent dilution), angel $100K at $1 million (9 percent), super angel $300K at $1.5 million (16 percent), micro-VC $640K at $2.6 million (20 percent). The caption is “valuation depends on who you take money from.”

What moves a seed valuation, in the essay’s order:

• Traction comes first. By her rule of thumb, 100,000 users gathered in about six to eight months gives you “a good shot at raising $1M,” and the faster you got them, the more they count.
• Reputation comes next: a Jeff Bezos can command a high valuation for any idea, and founders with prior exits generally get more. She notes Kevin Systrom (Instagram, then Burbn) and Ben Silbermann (Pinterest) raised without traction or prior success because their investors trusted intuition.
• Revenue matters more for B2B. For consumer start-ups, charging users can lower a valuation, because it slows growth.
• Distribution channel and how hot the industry is help but will not produce a high valuation by themselves, since “investors travel in packs.”

Do you need a high valuation? Not necessarily. A high seed price means the next round has to be higher, and her rule of thumb is roughly 10x growth within 18 months. Miss it and you face a down round or run out of cash. She lays out two strategies. “Go big or go home” means raising as much as possible at the highest price and spending fast, so a big step-up can let the seed round “pay for itself”: 30 percent total dilution instead of 55 percent. “Raise as you go” means taking only what you need and growing steadily.

Series A and scaling: multiples. Growth is the main metric, and investors use the comparables method, citing Fred Wilson’s AVC post: take the valuation-to-revenue multiple of similar companies and multiply your revenue by it. The infographic’s “How to Calculate Valuation” track also shows the fuller process: find similar companies; calculate the multiple (enterprise value over earnings or users); take revenue this month, this year and next year; build best, worst and base cases; triangulate them; project when the company will exit; and discount earnings for the time value of money. The 2012 average it gives for this stage is about $2.9 million invested at an $8 million valuation.

The investor’s math. The investor starts from the exit. Her example assumes an Instagram-style $1 billion sale less about $56 million of total funding, leaving roughly $940 million of value created. A seed investor who started at 20 percent is diluted to about 4 percent by later rounds, which comes to $37.6 million. If she put in $3 million for that 4 percent, that is a 10x return, which the essay says only about a third of companies in top-tier VC portfolios deliver. Preferred shares, convertible notes and caps are described as “just anti-dilution measures.”

Does the starting valuation matter? The post contrasts Dropbox and Instagram, both one-person start-ups that became billion-dollar companies. Drew Houston took about $20K from Y Combinator for 5 percent ($400K pre-money), while Kevin Systrom took $500K from Baseline Ventures for about 20 percent of Burbn ($2.5 million). The post leaves the question open.

Option pool. The pool is usually 10 to 20 percent, and a bigger pool means a lower real valuation, because it is carved out of the pre-money. Her worked example: $4 million pre-money plus $1 million new money is $5 million post-money. If the term sheet asks for a fully diluted 15 percent pool counted in the pre-money, that is $750,000 taken off the pre-money, so the true pre-money valuation is $3.25 million.

Exit. The infographic ends at exit. The company is an acqui-hire if the team is strong but the product isn’t taking off, an acquisition if the product has traction but not enough revenue for an IPO, and an IPO otherwise (it shows listing thresholds of “$11M profit, any valuation” and “$100M revenue, $500M valuation”). The ways to value it are comparables, replacement cost (“rebuilding from scratch”) and discounted cash flow (“money in the future is worth less”). The last panel is a scale in the public markets: “present revenue” against “promise of growth,” with realists on one side and believers on the other.

The post’s listed sources are the Halo Report (Angel Resource Institute), the NASDAQ and NYSE listing requirements, and Fred Wilson’s AVC blog.

Full text

Archived privately against link rot: ../attachments/how-startup-valuation-works-illustrated/how-startup-valuation-works-illustrated.md. The full infographic (900 × 3885) is saved alongside as how-startup-valuation-works-infographic.png.

Connections

• Valuation: the founder’s view of valuation, where the number is mostly a negotiated price for a share of the company rather than an estimate of worth. That matches Brent Beshore’s line that “every value and formula is negotiable.”
• Valuing Young, Start-up and Growth Companies: Aswath Damodaran takes the comparables-plus-exit-multiple method this post teaches and argues it turns the projected value into “a bargaining point between the two sides rather than the subject of serious estimation.”
• Valuing High-Tech Companies: McKinsey’s case that multiples are “of little use when earnings are negative,” which is the method this post recommends for Series A.
• Dilution: the seed-versus-growth dilution math, the angel diluted from 20 to 4 percent, and the option pool coming out of the pre-money.
• Multiples: the Series A comparables method.
• Seed Investing: 2012 check sizes and valuations by incubator, angel, super angel and micro-VC.
• Fred Wilson: his AVC post on valuation multiples is the method the post cites.
• Y Combinator, Dropbox and Instagram: the valuation comparison.