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1
Know your metrics
2
Build a financial model
3
Research your market
4
Tell a compelling story
5
Understand the valuation methods
6
Negotiate smartly
7
Here’s what else to consider
If you are an entrepreneur looking for funding from venture capitalists (VCs), you need to know how to prepare for a VC valuation. A VC valuation is the process of estimating the value of your startup based on various factors, such as your market size, traction, growth potential, competitive advantage, and risk. A VC valuation can determine how much equity you have to give up in exchange for capital, and how attractive your deal is to investors. In this article, we will cover six effective ways to prepare for a VC valuation and increase your chances of getting funded.
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- Eva Dobrzanska Head of Investments at FundIQ + Sixth Wave Ventures
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- Ashraf Sheikh Strategic Revenue + Growth Driver 🌱
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1 Know your metrics
The first step to prepare for a VC valuation is to know your key metrics and how they measure your performance and progress. These metrics can include your revenue, gross margin, customer acquisition cost, customer lifetime value, churn rate, retention rate, and growth rate. You should be able to explain how these metrics are calculated, what they mean, and how they compare to your industry benchmarks and competitors. You should also be able to show how these metrics have improved over time and how they will continue to grow in the future.
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Let's say you've started a fitness app. Initially, you had a high churn rate because the app had a lot of bugs. After several updates, you managed to lower the churn rate and increase the customer lifetime value. You're not just fixing problems; you're creating loyal customers. When you're pitching to a venture capitalist, you would show these metrics and the improvement over time to prove that you're a good investment.It's not just the numbers but the story they tell that could be compelling to a venture capitalist. Also, venture capitalists may look at "softer" elements like your team's experience and your company culture. These may not be "metrics," but they're still part of the overall valuation.
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- Ashraf Sheikh Strategic Revenue + Growth Driver 🌱
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📊 VC Valuation Prep: Metrics Mastery! 🚀📈📈 Know Your Metrics:Understand key metrics like revenue, margin, CAC, CLV, churn, retention, growth.📊 Benchmark Insights:Compare metrics to industry benchmarks and competitors.Example: SaaS startup Sisense used industry metrics to showcase growth potential.📉 Historical Trends:Show how metrics have improved over time.Example: Slack highlighted user growth trends to attract VC investment.📈 Growth Projections:Outline how metrics will continue to grow.Example: Uber projected market expansion to woo investors.📣 Clear Communication:Articulate the significance of metrics and their impact on valuation.
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- Wojciech Drewczyński VC. Top Voice. I help founders from pre-seed to exit. On a mission to fuel the next generation of startup heroes -> Let’s build the next big thing together
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Your metrics are important. Your growth rate is even more critical. It shows investors whether a company is weak, average, or top. Investors want to work with the best. And with the most ambitious. If you're growing 50% YoY, that's nice, but it's not for VCs. If you're growing 2x YoY, you're a promising startup but still far from the best. Historical performance is key to gaining investor interest. But you need to show an ambitious plan to make a decision. If you are conservative in your forecasts and show a slower growth rate, you have lost. In venture capital, no one wants to invest in safe projects. Everyone is looking for the ones that will fly to the moon. They are the only ones that can give you a chance for extraordinary returns.
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2 Build a financial model
The second step to prepare for a VC valuation is to build a financial model that projects your income statement, balance sheet, and cash flow statement for the next three to five years. A financial model can help you estimate your future revenue, expenses, profitability, and cash needs. It can also help you demonstrate your assumptions, scenarios, and sensitivities. You should be able to justify your projections based on your historical data, market research, and growth strategies. You should also be able to show how your financial model aligns with your vision, mission, and goals.
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- Ashraf Sheikh Strategic Revenue + Growth Driver 🌱
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💰 Financial Model Magic: VC Valuation Prep! 📊💼📈 Build a Robust Model:Project income, balance sheet, and cash flow for 3-5 years.Example: Zoom's financial model showed scalability and attracted VC funding.📚 Justify Assumptions:Back projections with historical data and market research.📊 Scenario Planning:Create different scenarios and sensitivities to show flexibility.🎯 Alignment with Vision:Ensure the financial model aligns with your startup's goals.📊 Forecast:Use the model to forecast revenue, expenses, and cash needs.
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- Dr. Zekeriya Bildik, CMA, CPA Director of Finance / CFO / Startup Mentor
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Building a solid financial model where your business vision takes shape in numbers and projections. By creating a robust financial model, you not only showcase your business's potential but also demonstrate your commitment to transparency and planning. Best in practice is to build three financial statement model for at least 5 years accompanied with scenario and sensitivity analysis upon key metrics like A/R days, A/P days, revenue growth, COGS, Cost Saving rates, WACC, EV/EBITDA...
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Building a financial model for VC valuation is not easy. Some of the shortcomings include: Overly optimistic projections with flawed revenue projections and underestimated costs, portraying an unrealistically favorable scenario. Adopting a conservative approach in forecasting and using realistic market assumptions is key. Some models are not structured with enough flexibility and fail to adapt to changing market conditions or different scenarios, which is a common scenario in startups.Some financial models ignore prevailing and changing market conditions which can lead to flawed valuations. Overly complex financial models can be difficult to understand, analyze, and explain to potential investors.
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3 Research your market
The third step to prepare for a VC valuation is to research your market and understand its size, growth, trends, opportunities, and challenges. You should be able to quantify your total addressable market (TAM), serviceable addressable market (SAM), and serviceable obtainable market (SOM), and how you plan to capture them. You should also be able to identify your target customers, their pain points, needs, and preferences, and how your product or service solves them. You should also be able to analyze your competitors, their strengths, weaknesses, and market share, and how you differentiate yourself from them.
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- Yorai Fainmesser General Partner at Disruptive AI Venture Capital,Artificial Intelligence strategic expert.
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First remember, that investors are not only interested in the bottom line numbers but also in the way you interpret your research findings. Waving totals, from basic Google search is not helping.Demonstrate your thoughts on your target market and the theG2M ideas, through that valuation. Assuming numbers are high enough, for me it is most important to focus on the total segmented sector for the product class but also understand how this total is built.For example, SAAS solution for drug discovery labs- What is the total expense on SAAS platforms in Labs? What is the average subscription paid by a single lab? How many labs are there in the target region? what is the accepted landing ticket for SAAS? Are there different SAAS categories?
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- Dr. Zekeriya Bildik, CMA, CPA Director of Finance / CFO / Startup Mentor
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Thorough market research is a treasure map on your path to VC valuation success. It's where you uncover valuable insights, trends, and opportunities that can make your business shine. By investing time in market research, you not only showcase your understanding of the industry but also demonstrate your readiness to navigate its challenges.
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4 Tell a compelling story
The fourth step to prepare for a VC valuation is to tell a compelling story that showcases your vision, value proposition, traction, team, and impact. You should be able to articulate why you are passionate about your idea, what problem you are solving, how you are solving it, and what impact you are making. You should also be able to highlight your traction, such as your customer base, revenue, partnerships, awards, testimonials, and press coverage. You should also be able to introduce your team, their backgrounds, skills, roles, and contributions. You should also be able to convey your culture, values, and mission.
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Valuations are as much an art as they are a science. While numbers and metrics are critical, the story, team, IP, and vision behind the startup are equally important. Being able to compellingly articulate your vision, the problem you're solving, and how you intend to capture the market can significantly influence the valuation you receive.
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Imagine you've developed an app that uses machine learning to identify early signs of plant diseases, targeting hobbyist gardeners and small-scale farmers. You're passionate about sustainable agriculture and food security. You've had a beta version out for six months with 10,000 downloads and lots of positive reviews. Your team is a mix of agronomists, data scientists, and marketing experts. This makes for an engaging and compelling story to tell a VC. You're not just a smart tech play; you're a solution to a real-world problem with a team capable of pulling it off.Good storytelling is as much about the delivery as it is about the content. VCs often look for charisma and conviction as markers of leadership.
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5 Understand the valuation methods
The fifth step to prepare for a VC valuation is to understand the valuation methods that VCs use and how they apply to your startup. There are different valuation methods, such as the market approach, the income approach, and the asset approach, and each one has its own advantages and disadvantages. You should be familiar with the common valuation methods, such as the comparable transactions method, the discounted cash flow method, the Berkus method, and the venture capital method, and how they work. You should also be aware of the factors that can affect your valuation, such as the stage of your startup, the industry, the geography, the market conditions, and the deal terms.
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Suppose you run a SaaS (Software as a Service) startup focusing on e-commerce platforms. You might use the comparable transactions method by looking at similar SaaS companies that recently received funding. Alternatively, you could use the DCF method, estimating future cash flows and discounting them back to their present value. You'd also look at how other SaaS companies in the e-commerce space, in your country or region, are valued. This will give you a fuller picture.Knowing valuation methods is one thing, but applying them in a way that maximizes your valuation can be an art form in itself. If you know that SaaS companies in your space are valued on a multiple of revenue, you might focus on ramping up sales before a funding round.
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6 Negotiate smartly
The sixth and final step to prepare for a VC valuation is to negotiate smartly and confidently with your potential investors. You should be prepared to discuss your valuation expectations, your funding needs, your equity dilution, and your exit strategy. You should also be ready to answer questions, address objections, and provide evidence to support your claims. You should also be respectful, flexible, and realistic, and avoid common pitfalls, such as overvaluing or undervaluing your startup, accepting unfavorable deal terms, or losing control of your startup.
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- Eva Dobrzanska Head of Investments at FundIQ + Sixth Wave Ventures
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Be prepared to explain the reasoning behind your valuation and funding needs. Knowing how much equity you can sell will help. On average, founders give 10% - 15% at Pre Seed, 10-20% at Seed. Ideally, you should still own at least 51% of your company at Series A. You can encounter Seed VCs asking for ~ 25% equity (or even more) which could come with a promise of support and “being a hands-on investor”. You should always clarify this: “Can you give me examples of how have you supported your portfolio companies? How many team members are tasked with this, how many hours per month on average, and what is the level of their seniority in your fund? On average, how many portfolio startups can be ‘assigned’ per 1 member of your team?”
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- Dr. Zekeriya Bildik, CMA, CPA Director of Finance / CFO / Startup Mentor
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By approaching negotiations with preparation, clarity, and a win-win mindset, you not only secure the best terms for your business but also build a strong foundation for a fruitful partnership with VC investors. It is one of the fundamental competences needed in business life. Convertible notes can have a substantial impact. Suppose you opt for a convertible note with a favorable conversion rate. In this case, if your company experiences rapid growth and company valuation increases, the VC's investment converts into equity at a more advantageous rate, resulting in less dilution for you as the founder. The cliff and vesting period can provide incentives for team commitment and mitigate potential issues. VC will make it very welcome.
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7 Here’s what else to consider
This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?
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- Eva Dobrzanska Head of Investments at FundIQ + Sixth Wave Ventures
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'Use of Funds' is scrutinized in detail by VCs, who want to ensure most of their investment goes towards activities that result in direct growth of the business (rather than covering operational expenses). A low % allocation of funds to Tech/ Product Dev will prompt questions such as: is the tech fully built? Where is it being developed? Are you planning to continue developing it? Is it easily replicable? (🚩)A high % of funds on Key Hires could prompt an investor to scroll to your financials to see Revenue projections, and question how many Salespeople you’re planning to hire, as they want to know your sales efficiency and how much of their investment will be converted into Revenues.
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The #1 thing (in my opinion) to prepare for any valuation discussion with a VC is to have more than one lead investor interested.
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- Dr. Zekeriya Bildik, CMA, CPA Director of Finance / CFO / Startup Mentor
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Valuation isn't solely based on quantitative analysis found in P&L, Balance Sheet, and Cash Flow statements. It also encompasses an evaluation of your company's culture, the expertise and vision of your management team, and its alignment with ESG (Environmental, Social, Governance) principles. Building a company that fully adheres to corporate governance principles and structures can potentially boost your valuation by 15% to 30% or more.
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