8. Valuation, Part 1 (Jeffrey Carter)

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Jeffrey Carter  joins Nick on The Full Ratchet to discuss Valuation, including:

  • jeffrey carterWhy is the valuation and price/share a critical deal term for investors to be well-informed about?
  • What is the difference between a pre-money and post-money valuation and can you give us an example that illustrates what each would be for a standard deal?
  • What does the phrase “fully diluted” mean and how does that relate to valuation and the employee option pool?
  • Why are warrants sometimes referred to as “stock options” and how do they impact valuation indirectly?
  • Can you explain what an “up round” and “down round” are?
  • What are the main factors that impact valuation?
  • Many factors are qualitative…  if we focus on the quantitative factors, can you give us a couple examples of how a venture investor may determine/calculate valuation?
  • If I were a founder, what advice would you have to get a better valuation?
  • As an investor, if you love the idea, team is great, but valuation is too high…. how do you approach the negotiation process?

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Key Takeaways:

  1. In every round, an entrepreneur will give up between 15-25% equity.  At the beginning of a startup’s life, in the garage, they always own 100%.  But at the end, when they exit, often the founders will own about 15%.  This is the standard and should not be a surprise to the entrepreneur.  If a founder is unwilling to offer the standard amount of equity and/or an investor prices a company too high, during an early round, it becomes very difficult to raise subsequent rounds… especially if it’s a down-round or flat-round.  This is where Jeff mentioned Airbnb… it could be a brilliant idea in a Billion $ market, but an entrepreneurs ability to continue to fundraise depends heavily on the round not being priced too high.
  2. The elements that impact valuation positively.  Jeff mentioned a few, including:
    • Market Size- how big is the mkt the startup is going after?
    • Disruption- How disruptive is it?  Is it creating new markets?  Is it removing middle-men that create no value?
    • Experience- Has the entrepreneur done it before and exited?  Does the entrepreneur have a lot of experience in the target market?
    • Risk- Ultimately if the risk is a little less, you are going to give them a better valuation
  3. Honesty and transparency.  When Jeff sees a valuation that isn’t realistic, he’s straightforward and shows them the data.  The discussion can be uncomfortable and adversarial, but it’s also indicative of how the relationship is going to go.

Tip of the Week: Know Your Valuation