Seed Rounds: How To Pick A Valuation

I can’t tell you how many times I’ve had this conversation. A founder is about to raise their first round and asking me how to value their company. [1]

There’s a reason it’s so difficult to figure out - valuations have little basis in reality for early stage companies. You evaluate the team, product, market and other variables - then, make a general guess.

Before I go on, if you read nothing else, read this:

Your #1 goals is to get your company funded, so you can build a big business. Funding lets you invest in growing your company faster than revenue growth would normally allow. Do what you can to get your company funded and get back to work generating value.

Here are some ways to value your company:

1. Market size

A big market determines the upside potential. In a world where only the 1000x companies make back portfolios, this is really important. [2]  This can often justify a higher valuations - and for good reason. For some investors, this is the most important attribute and they won’t invest unless it’s a huge market.

2. Revenue

Revenue is how traditional businesses get valued. Early stage companies often don’t have revenue or have revenue so low, it’s not a real indicator of future potential. Companies like Facebook and Twitter didn’t figure out revenue for a long time. This is the main reason the process of picking a valuation can feel so ambiguous. With that said, if you have revenue, this is something you should emphasize.

3. Month on month (MoM) growth

To become a big company, you need high MoM growth for years (PG: Startups = Growth). 20% MoM growth is the gold standard - the longer and more consistent you hit high MoM growth, the better. Even a product an investor doesn’t fully understand - for example, an app that self-destructs the photos it shares - starts to look really good with high MoM growth. This works for revenue or active users.

4. Active users

Free, engaged users are a proxy for revenue, as long as you understand when a free user is valuable and when it isn’t. The threshold is generally higher for consumer startups (Ten million users is the new one million). Moreover, the engagement of your paid users are also important, even though they’re paying you, since it’s a leading indicator of churn.

5. Team

Everyone talks about the Stanford / MIT teams. It certainly can help boost a valuation, but isn’t necessary. Domain expertise can also help.

6. Valuations of other companies like you

Relationally, you can compare your valuation to other companies on Angellist, Y Combinator, 500 Startups or elsewhere.

7. Acquisitions of other companies like you

This is helpful in determining a valuation, since it shows real liquidity for what companies will pay for a company like you, instead of what an investor will pay to invest.

8. Raising momentum / high demand

This method of valuing a company is further from reality than most attributes. If your company is in high demand, it drives the potential valuation up. Hopefully, it’s in high demand for good reasons, otherwise you risk a down round in the future.

9. Accelerator

Being part of an accelerator can help your valuation, since you’ve at least been partially vetted, which decreases some, but definitely not all, of the risk.

Things to note about valuation:

1. Your outcome will likely be binary

I spoke to a YC class about fundraising a few years ago and I still believe this - I’d rather raise $1m at a lower cap than $100k at a higher cap. The former will get us to the next stage as a company. The latter won’t be enough money to grow and without the capital to grow, could risk failing or a down round.

2. The valuation only exists if investors validate it

Traditionally, there’s a lead investor that validates a valuation, but a lot of companies now raise without a lead. By getting a few investors to buy in at a specific valuation, they’re effectively validating the amount. Either way, your valuation doesn’t truly exist until it’s validated.

3. Don’t risk a down round

A down round happens when the valuation of your next round is less than your current round. No one comes away from that undamaged. That can happen when people are too aggressive about their valuation in that first round. Don’t let that be you.

4. Terms often matter more than the valuation

For a higher valuation, you may be giving up some control, like a board seat. I’ve also seen people raise on 2x+ pro-rata, which means that the investor has the option of doubling their stake in the following round, which I think is generally a bad idea. I’d keep your terms as clean and standard as possible. [3]

5. Valuation pride

Why do people push super high valuations? It’s one of the few moments in your company’s history where you can get a stamp of validation. Just like good grades or good schools help drive your self-worth, a great valuation can do that too. It’s something you can tell others or use to compare. So, the bigger the stamp, the more likely you’re seemingly doing well. Don’t be tempted by this.

6. Map out multiple stages of financing

Take a moment and project out your equity over multiple rounds of financing. You need to make sure there’s enough equity to sell, while keeping enough equity for the founders and team. I hear of companies that sell 50% of their company for a few hundred thousands dollars. That won’t leave enough equity to sell for future financing rounds. (The Benefits of Building a Company in the Bay Area)

7. Drive for a ‘fair’ valuation

That probably depends a lot per company, but I kept that word in my head as I figured everything out.  

8. Make sure your valuation doesn’t exclude great investors

Even though it’s hard to know an investor’s value add in advance, make sure you’re not picking a valuation that prevents great investors from investing (Investors and advisors: the crowd, the ringside, and your corner). Note, if it’s a great company, not all great investors will walk away from a high valuation (Sam Altman: Upside risk).

9. Be nice

Invariably, you’ll run into investors that think your valuation is too high. The only right behavior is to be consistently nice and explain your thought process (Treat investors well when fundraising).

10. Valuation versus percentage ownership

Some investors are more interested in the percentage of the company they own, versus the valuation. In that way, you might end up with a higher valuation than you would have had otherwise. You can certainly take this approach to picking a valuation, but just make sure you’ll be able to at least grow into that valuation - preferably grow significantly past it - by the time you raise your next round.

You’ve probably noticed at this point that there’s no clean formula. Even though it’s inexact, investors will want to know the thought process behind the valuation you pick.

Certainly, there are bad valuations, but there’s a larger range of gradations of good valuations and I wouldn’t stress about small differences between the gradations in the good range.

Good luck figuring this out. The key is to not spend too much time thinking about it. Some incredible companies, like Dropbox and Airbnb, got valuations that would seem extremely low in this market for their first rounds.

In the end, it’s your ability to execute that will turn your company into a big one - not your valuation. It’s more important to close the round, get the money in the bank and get back to building.

Would love to hear what you’ve learned about valuing early stage companies in the comments.

[1] This is mainly about your first round. I think a lot of the lessons can apply to later rounds though.

[2] Articles on needing the companies with 1000x returns to justify your portfolio:
Black swans
Upside risk

[3] YC has standard docs you can use. 

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14 responses
Great post. I wrote a post that's somewhat related at I think your point about fairness is one of the most important ones to me (as an investor). I don't mind if the valuation is high if that valuation is justified, but it's a big turn-off when someone raises the price because there is enough interest from price-insensitive investors or for some other reason that's not related to the fundamentals of the company and the team. Also, looking at comps on AngelList is a terrific tip.
This is excellent information - thank you Joseph.
Great points made that will certainly come in handy as I put together round 2 angels for my Friendly Beds. Any tips when the product is innovative and requires time to build a market base?
Great post Joseph! Especially important to highlight that out of the nine attributes that get measured for valuation #2, 3, & 4 are the easiest ways to drastically change the valuation. The others (market size, team, and so on) are necessary, but it is rare one of them will drastically change the valuation.
Thanks for your thoughts on this often misunderstood, more-art-than-science conundrum experienced by many entrepreneurs (including myself), Joseph. Curious to get your thoughts on market barriers (specifically patents and IP) as they pertain to seed round valuations. Does an appropriately secured patent increase the company's value at the seed stage? If so, how much (percentage) on average? Cheers from Kansas City!
Matthew, I think you’d have to make the case that it really makes an impact on the future of your business. I think for most patents, the impact is pretty marginal - so I’m not sure if it’d impact the valuation that much. Anyway, that’s just my opinion. Would love to hear answers you get from other people. Cheers from San Francisco!
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