What goes into assessing a startup's value, and how should we think about valuations? originally appeared on Quora: the place to gain and share knowledge, empowering people to learn from others and better understand the world.
Valuing a company when it's public is easy. It is just the market capitalization that day. Valuing a start up is hard, because an investor is projecting what the future value of the business will be based on very limited information. As early-stage startups progress, it becomes easier and easier to compare them to public comparable companies and the private market valuation will converge with the public market valuation.
So, how do you value a seed or series A company? It's not based on metrics or multiples or any kind of number. It's based on supply and demand. Which investors are willing to pay how much for a fraction of the business. In other words, it is an auction with a handful of participants. The better the startup can run the auction, the higher the demand for the shares, the greater the price.
But the math every venture capitalist is doing in her head when she hears a pitches this. If the company is raising $2 million, can I buy 20% ownership of the business for that amount? In other words, the value of the business will be $10 million.
Each venture-capital firm has a model for how much ownership of the business they would like to own at each stage. They take the total amount of capital the company is looking to raise from that investor, divided by the ownership to get an approximate valuation and ask themselves if they would like to be investors in the business at that price.
Many investors will ask founders to justify the total raise size by asking them for a financial plan which includes a total amount of cash burn over the next 18-24 months. Of course, they will add a buffer to inflate the company from some unforeseen delays. But that will be the rough range of raise size at the early stage.
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