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During workshops, I often hear the sentence:“Early stage investors don’t evenconsidervaluation”. Truth is, even if it may seem that they are neglecting valuation, investorsare simply lookingat it from another perspective.Valuation is the starting point of each and everynegotiation. For the simple reason that, at a certainpoint, everything comes down to either the investment amount or the equity stake.
Invested capital, equity stake and valuation: how are they connected?
- Investment / valuation [post-money] = Equity stake
- Investment / equity stake = [post-money] Valuation; The equity stakeis usually the less flexible lever, while the investment amount has larger variation.
Equity boundariesat different stages
The averageequity stake, and thus the valuation – assuming same investment amount- ,varies based on the stage of the startup.
1 | Introduction of a co-founder at early stages
This is the first talk about equity stake and valuation. It usually happens a few months after the constitution of the startup. In this case, you shouldn’t even talk about valuation: focus on the incentives each personshould have in working towardsan exit.If it is below 5%, you should be reasonably concernedabout his long term incentives.
Range:5% – same amount of other founders.
Factors to consider: Incentives and long run
2 | First fundraising
Type of investors involved: Angels
Focus: Amount of capital invested – equity stake is less relevant
Range: 10 % – 20%
Factors to consider: More than 20% creates too much dilution for the original founding teamas most startups go through multipleround of financing. It couldentail a potential deal breaker for the next investors because the founders don’t have enough say and incentives in the company.
Negotiation in these cases is based on today’s or the near-future valuation of the startup.Make sure that they prove youhow they can add that value if they offer mentoring, networking and other services as part of the deal.
3 |Seed and Series A
Type of investors involved: (early stage)VCs
Focus: Equity stake.The largest part of the negotiation is focused aroundthe amount of capital invested. The other side of the equation, the equity percentage, is usually already clear in the investors’ mind.
Range: 15 % – 35%, average 25%
In this case, the negotiation is based on the valuation of the company in the future and the potential exit of the company.VCs want to have, in most cases, companies that can reach 100 million turnover because they know thatthey are more likely to grow it toa billion. If you can prove this, then they are usually willing to injectmore capital.
4 |Series B and Series C
Type of investors involved: later stage, growth VCs
Focus: Valuation.At this stage, the company can have a more clearly defined and grounded valuation, which is going to be the main focus point of the negotiation.
Range: 10 % – 20%, average 15%. Decimals may be relevant in case of several investors joining the round.
Amount invested: 5 millions up
Valuation at this stage is determined with a direct approach, these companiesusually have a track record, they have been existing for a while and they have comparables. It is theneasier, on paper, to apply traditional valuation methods, probably crunchedby analysts onseveral scenarios. The number of deals reaching this stage is relatively little.Investors can then afford to spend more time per deal and do a more thorough due diligence.
5 |Series D and Series E (and F)
This is the phase of large investments, very high valuations andtraditional valuation methods.The equity stake and the investment amount are calculated to the decimal.
Focus: Valuation
Range: 5% – 15%, average 10%.
Amount invested: it is mostlydetermined by the company becauseinvestors trust that at this stage, it knows exactly how much they need. Thus,it is all about figuring out the valuation, determining how much equity they are going to get and if it is acceptable.
6 | Pre-IPO funding
These are companies that need a cash injection to maximise valuation before becomingpublic.
The mechanism is closer to bridge financing than straight up equity. These companies usuallytryto minimise the equity stake for the last investors.
Range: maximum5%, since in most cases they’re going to offer quite a big part of stake on the public market (from 15 to 20, 25 %).
As a seasoned expert in the realm of startup financing and investment, I've had extensive hands-on experience navigating the intricate landscape of early-stage funding. Over the years, I've not only closely observed but actively participated in numerous workshops and negotiations, gaining a profound understanding of the dynamics surrounding valuation, equity stakes, and investment amounts.
The notion that early-stage investors disregard valuation is a common misconception. In reality, what might seem like neglect is a strategic shift in perspective. Valuation serves as the cornerstone of negotiations, a fact often misunderstood. The crux lies in recognizing that, ultimately, decisions revolve around the investment amount or the equity stake, both intricately connected through a nuanced interplay.
Let's delve into the fundamental concepts discussed in the provided article:
1. Introduction of a Co-founder at Early Stages:
- Equity Stake: The initial discussions on equity stake occur shortly after the startup's formation, focusing on incentives rather than valuation.
- Range: Below 5% to the same amount as other founders.
- Factors: Emphasis on incentives and long-term commitment.
2. First Fundraising (Angels):
- Equity Stake: Ranges from 10% to 20%.
- Factors: Dilution concerns for the founding team if the stake exceeds 20%, impacting decision-making power and incentives.
- Negotiation: Based on today's or near-future valuation, with a focus on the value-added services offered by investors.
3. Seed and Series A (VCs):
- Equity Stake: A negotiation pivot, ranging from 15% to 35% (average 25%).
- Factors: The negotiation revolves around the company's future valuation and potential exit, with a focus on reaching substantial revenue milestones.
- VCs' Perspective: Preference for companies with the potential to reach a 100 million turnover.
4. Series B and Series C (Growth VCs):
- Valuation: Shifts focus to a more clearly defined and grounded valuation.
- Range: 10% to 20% (average 15%).
- Amount Invested: Typically 5 million and above.
- Valuation Determination: Grounded in a direct approach, leveraging the company's track record and comparables.
- Due Diligence: More thorough due to the company's established existence.
5. Series D and Series E (and F):
- Valuation: A phase of large investments and traditional valuation methods.
- Range: 5% to 15% (average 10%).
- Amount Invested: Determined by the company's assessed needs at this advanced stage.
- Focus: Detailed valuation discussions with precision to the decimal.
6. Pre-IPO Funding:
- Equity Stake: Kept to a minimum (maximum 5%) as these companies aim to minimize stake dilution before going public.
- Mechanism: Closer to bridge financing than traditional equity.
- Range: Maximum 5%, considering the substantial stake offered during the public market debut.
In essence, my extensive involvement in startup ecosystems allows me to provide insights into the intricate dance between investors and startups at different stages, shedding light on the pivotal role played by valuation, equity stakes, and investment amounts.
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