Today’s question comes from John. John’s question can really be broken down into two parts: 1) How do I know what my startup is worth before launching it? 2) Are there some general rules about how much money I should raise or what my valuation should be if I haven’t launched a product or done any marketing yet.
This is one of the most common questions we get from the founders we work with. Most of the startups we work with are pre-product so this is something we spend a lot of time with them discussing.
Early stage startups should spend time on their valuation.
The truth is that if you don’t have a product and if you don’t have some IP (intellectual property) that you’ve developed, you don’t have a valuation. Your startup is just your idea. It’s worth nothing. So when you’re raising money, it’s not on its value, it’s on its potential. The valuation numbers will fluctuate greatly once it actually gets to market. It will vary depending upon how much traction it gets (or doesn’t get), how it sells, etc.Your startup is just your idea. It's worth nothing. So when you're raising money, it's not on its value, it's on its potential. Click To Tweet
You don’t have to go into meetings with investors knowing your valuation. Oftentimes if you do come in with a valuation, investors will scoff at your number because there’s no way to prove it.
Come in with how much money you need. For example, you know you want to launch in three cities within the next six months and you need $50k for each city. On top of that, you know you need $50k for product development and you want runway for a year – $50k in salary for both you and your co-founder. Now you know before you go into these meetings that you need $300k in funding to get your idea up and running.
The negotiation is now around how much you are willing to give up, not around your valuation. I don’t recommend giving up more than 30 percent in the first round of funding. Anywhere between 20-30 percent and you’re generally safe.
By doing that, you’re giving yourself a type of valuation. If you give up 30 percent for $300k, then you’re basically saying that your company is valued at $1M. Everyone involved knows that’s not a real number until you do something with your product, but they have essentially worked backwards to enable you to get your product to market.
Now, $300k probably seems like a lot of money. Do I really need to raise that much? Some investors are good about understanding the lifecycle of a startup. The idea of zero to one (there’s a great book by Peter Thiel with the same title), one to ten customers, ten to one hundred customers, etc. The idea that your startup has a lifecycle as it starts and as it grows, generally focused around customer acquisition.
You could raise less than your initial needs assessment indicates and just get enough funding to get the product developed. We’ve had startups that raised just enough to get their MVP created and then went back to the investors to show them their progress before raising more funds.
You don’t have to raise the max of your initial needs but in an ideal world you want to be able to raise enough to have a year of runway. If you’re new to startups then it’s ok to raise for product development and then work closely with the investors so that they are open to you coming back once you’ve shown some traction to raise more money for marketing and runway. Many times, investors will understand why you are structuring your deal that way and will appreciate that you want to show what the product potential is before raising too much.
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