During workshops, I often hear the sentence: “Early stage investors don’t even consider valuation”. Truth is, even if it may seem that they are neglecting valuation, investors are simply looking at it from another perspective. Valuation is the starting point of each and every negotiation. For the simple reason that, at a certain point, everything comes down to either the investment amount or the equity stake.
(Author: Giulia Girardi, Equidam / Image Credit: Volkan Olmez)
Invested capital, equity stake and valuation: how are they connected?
- Investment / valuation [post-money] = Equity stake
- Investment / equity stake = [post-money] Valuation; The equity stake is usually the less flexible lever, while the investment amount has larger variation.
Equity boundaries at different stages
The average equity 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 person should have in working towards an exit. If it is below 5%, you should be reasonably concerned about 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 team as most startups go through multiple round of financing. It could entail 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 you how 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 around the 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 that they are more likely to grow it to a billion. If you can prove this, then they are usually willing to inject more 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 companies usually have a track record, they have been existing for a while and they have comparables. It is then easier, on paper, to apply traditional valuation methods, probably crunched by analysts on several 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 and traditional valuation methods. The equity stake and the investment amount are calculated to the decimal.
Range: 5% – 15%, average 10% .
Amount invested: it is mostly determined by the company because investors 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 becoming public.
The mechanism is closer to bridge financing than straight up equity. These companies usually try to minimise the equity stake for the last investors.
Range: maximum 5%, since in most cases they’re going to offer quite a big part of stake on the public market (from 15 to 20, 25 %).