How To Set The Right Valuation

Hey y’all — you know how on Shark Tank the founders walk in and say “I’m raising $x and a $y valuation” and it’s this take-it-or-leave-it amount?

Anyone who’s raised capital before will tell you that’s not how the real world works.

If you tried to do that in a pitch meeting there’s a decent chance investors would get confused, laugh, or end the meeting.

Setting your valuation should be a collaborative process to find the number that makes sense for both you and the investor.

You should come into it with a target range, but don’t be dead set on a specific number.

This week’s deep dive is taken from my course Set The Right Valuation and covers what your valuation actually is (and isn’t) meant to be about. The rest of the course shares my full 5-step framework for setting your valuation and more.

What Your Valuation Actually Is (And Isn’t)

What Your Valuation Isn’t

Let’s be honest.

In the early rounds the valuation you raise at isn’t about how much the company is worth.

The truth is that at that point, no one can predict how the startup will perform well enough to know how to value it.

It’s not until you get into the growth stage that investors will look to put a value on the round based on your revenue.

In the pre-seed, seed, and sometimes even Series A it’s not about that at all.

But at the same time, an early stage valuation isn’t just “made up” or picked out of thin air.

What it is about is:

What Your Valuation Is

Milestones

When you go out to fundraise you should have already identified:

• The milestones you plan to use the money to achieve

• How much cash you’ll need to burn in order to achieve the milestones

And achieving those milestones should be impressive enough to position your startup as an attractive investment for the next round of funding.

Yes, you should already be thinking about your next round.

If you’re raising venture you’re getting on a treadmill where you’ll likely need to raise again multiple times.

And if you don’t understand and can’t clearly communicate what you need to do with the money you’re asking for then investors will feel less confident trusting you with it.

Investors want to know the founders they’re backing and will be working with for years understand how venture works, because it implies the founders will make smart cash management decisions to keep the company alive without having to massively dilute existing shareholders.

Remember — investors meet a lot of founders, and (chances are) they don’t know you already. So your job is to convince them you’ll be a good steward of capital.

Having clear milestones that map out a logical path to get them a markup on their investment is a great way to do that.

Venture Math

There are two sides to venture math — the founder side and the investor side.

On the founder side, you want to minimize dilution so that you retain ownership in the company. You can only do this by accepting less money or putting a higher valuation on the company.

Since you’ve already set your milestones and know how much cash you’ll need to achieve them, your only option is to push for a higher valuation.

But this is a trap — if you push the valuation too high not only will investors lose interest or think you’re being unrealistic, you’ll also set yourself up for failure when you go to raise your next round.

Each time you raise you want to be able to show enough progress to justify a higher valuation, right?

If you set your valuation too high in this round there’s a higher chance you’ll need to raise a flat or down round next time. You can’t predict what the markets are going to do or what macro factors will effect them.

In the meantime, don’t be stingy with equity.

It might feel really good in the moment to secure a higher valuation, but that’s not always the right valuation.

On the investor side, each firm has ownership targets — they need to own enough of the company so that if it becomes a unicorn and has a liquidity event, it will return enough capital to cover their entire fund.

Most startups that a fund invests in will fail, so it’s critical for them to own enough of their winners that, even after multiple additional fundraising rounds where they get diluted, they’ll own enough to cover the fund.

Your valuation is the mutually agreed point at which both sides feel comfortable.

Valuations Should Be Collaborative

Setting the right valuation isn’t an adversarial process where you’re trying to out-negotiate the investor.

It’s a problem you’re trying to solve collaboratively.

They want to invest in your company, and you want them to — solve the problem by finding the valuation that doesn’t dilute you too much while also giving them enough upside to make it worth it for their fund.

In short it’s a compromise and, more importantly, it’s a critical moment to build a positive relationship with the investors who are agreeing to partner with you on the business.

If investors see you’re thinking like this, they’ll trust you more as a founder because they’ll see that you understand how fundraising works. It’s a way for them to de-risk the deal.

PS — I go much deeper on how to set your valuation and share my full 5-step framework in my course, Set The Right Valuation. This is the framework that helped us raise $15 million for my last startup, and has now helped members of my founder community do the same.

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