I have financed nearly 50 early-stage companies and the question of proper valuation comes up in every financing. There is the obvious tension: Generally speaking, the existing shareholders would like the highest valuation possible, while the new investors would prefer the lowest valuation. For founders, understanding how VCs will look at valuation is critical for a successful fundraising process.
For an investor, initial valuation is one of two determinants of eventual return. The other is the size of outcome. As an investor, you’re willing to pay a higher valuation if you think the outcome is going to be great (both in terms of size and probability). There are several factors that influence, for the investor, the probability of the company achieving the great outcome: experience of the management team, size of the market, attractiveness of the market, early customer proof points and initial traction.
How much weight the investor gives each of these factors changes over time. The largest swing is where we are in the market cycle. Right now, we remain in the second-longest bull market in equities of all time, so investors are generally feeling more optimistic. So I plan on updating this estimator when there is a major market shift (or when I get more data).
These ranges also vary quite a bit by individual VC. For instance, I personally tend to value the founding team above all else, as long as the market is attractive and I find the product compelling. So I will pay a higher valuation when I have great confidence in the founding team. Other firms may value the market opportunity higher though, for example.
To help SaaS founders get a more accurate sense of valuation for their Series A funding, I’ve set out to create a funding estimator that lays out the major variables that affect valuation amounts. The estimator can result in a fairly wide range, but at the very least serves as a guidepost.
A couple of caveats before we get into it: Numbers for each major section are cumulative. Pick the right number of “points” for management, market, traction, location and add together. Also, these numbers are most suitable for enterprise SaaS companies dealing with larger customers. While the variables are always important, the value attributed to them changes over time. And lastly, the competitive dynamic (number of firms that want to invest in your company) can make a big difference.
With these disclaimers, here are the variables, and how much “value” you can expect will be attributed to it:
Relevant prior experience but not as CEO
Founder contributed to the success of a prior venture, in a related market.
Repeat successful founder
Founder built prior business to a reasonable revenue level and/or achieved a good outcome for investors.
Hot space (AI, Big Data, AR/VR, Etc.)
Really big range. Large new market opportunity is one of the biggest drivers in a VC decision. If it’s not a big market, you probably can’t get it funded. Period.
Do you have a few customers?
Once you’ve moved past development stage, you are creating value
Do you have $1M-$2M ARR?
$1M ARR is a “magic” threshold for a lot of investors to create the next level of value
Do you have $2M-$5M ARR?
Over $2M in ARR puts you above most Series A-stage companies.
4. Silicon Valley location
Just having a Silicon Valley location is not enough, so you need some combination of the prior attributes, but generally Bay Area companies end up raising money at a premium.
Here are a few examples:
Example 1: Repeat CEO (10-20), interesting but not “hot” space, pre-revenue, Silicon Valley (5-10). Valuation range $15 million-$30 million.
Example 2: First-time founders without a ton of prior experience, located outside the Bay Area, a “boring industry,” and a $2-5M ARR (25-35). Valuation range $25 million-$35 million.
Example 3: Repeat CEO (10-20), hot space (5-15), based in Silicon Valley (5-10), with a few customers that can be referenced (5). Valuation range $25 million-$50 million.
Of course, this a fairly broad estimator and it won’t be tough to find outliers that break the formula — but, in general, it should lead to generating valuation ranges that could help SaaS founders wrap their heads around what is possible and what they should aim for with their first round of venture capital funding.