How are Valuations Determined for a Startup

For early stage venture capital deals there are a few general rules. First, a VC will have limits on what they'll fund based on an ownership position. Meaning, no matter how great the company, they need to have a certain percentage of ownership. For a series A deal the typical range is 20 - 50%. Given that they like certain ownership positions, the amount of money you raise seems to have little impact. So if you raise $1 million or $2 million, its unlikely that you sell twice as much of your company. So, my advice is to find the average deal size for a company at your stage and try and raise that amount of money and plan on selling 20 - 50% of your company. This way you are getting a market deal.

For example, if series A web companies are raising $3 million on average, try and raise that amount. It just makes things easier. Most series A venture capital firms will want to invest with another firm. Each firm will want in the area of 20%. So you sell 40% for the three million and you have a fair deal in today's market.

There are things that can help you get a better deal. If you can get multiple firms bidding, the price goes up, but it won't go totally crazy. So, while its good to have multiple term sheets, and you can get a better price, in most situations it will get you 10 - 20% better price.

Several VCs asked me during the process of what valuation I wanted. This is a trick question. The only answer to give them is "Lets see what the market says".

The important part about valuations is pitching enough firms and talking with enough people to understand the market conditions for your deal.

Now, if I was raising seed money, I'd try to do it as a debt deal to convert into the series A. This way, you avoid pricing the company. In a debt deal, the money converts at a discounted rate into the series A price. A 20 - 50% discount seemed like the range. Also, expect the discount to be deeper depending on the time it takes to get the series A funding. This is a good way to finance a company with angels.