Startups and Raising money: What is a company with no revenues worth?

The Hutch Report

Raising seed capital and figuring out company valuation is always a challenging and critical milestone in the early life of a start-up. Startups are awesome (if you are in with the right team)

You may have noticed from some of our previous posts on The Hutch Report, that we like start-ups. We have had experience in large, multi-national blue-chip companies as well as failed and even more fun, successful start-ups.

Raising money: What is a company with no revenues worth?

I am currently embarking on a new start-up in the fintech space and am confronted with having to answer this question. We are currently in the stage of seeking seed funding as well as first pilot customers and trying to do both things at the same time.

There are several challenges you can imagine for putting a value on the company. The major one being that with no revenues and no similar companies on the market, how do you value a company at this stage? Some call it art. Others try to make it a science, but if you are honest with yourself and with others you cannot claim it is a science. You can always try to justify the business value through the business plan, the potential addressable market size, and with sales + opex forecasts. Of course, you do need to calculate and prepare all of that. At the end of the day though, with just an idea, a few slide decks, some excel, and no customers and no revenues you really can’t justify anything other than whether or not your plan looks reasonable and potentially feasible. So, what does one do?

Thankfully, there are some commonly accepted principles for this stage of the game. One of the common principles is that the total of all actual seed money raised should represent 20% to 25% of the value of a company at post seed valuation. (I have actually seen amounts as low as 15% and as high as 30%).

The way we are approaching our seed raising round at the moment is as follows. We have calculated it will cost about US$ 1mm over a twelve-month period to get to our first commercial launch. We have a plan that details and maps out the specific costs. This includes development, admin fees, legal fees, as well as a shoestring budget for sales and business development. The business plan does show how quickly we can recoup this US$ 1mm in costs once we get to commercial launch and revenues. Therefore, we can clearly present where the money goes, how it will be used, the timing of when it is needed, and have reasonable calculation of the results the investment may yield. We are targeting a US$ 4mm post-money valuation with a US$ 1mm seed investment in exchange for giving up 25% of the company post-money.

Pre-money and Post-money: Valuation and Dilution

An important concept is the valuation of the company pre-money and post-money. After an investment round is completed the value of the company goes up by the size of the investment round, hence it is called the post-money valuation. So, in the example above, our company will be worth US$ 4mm once we complete our seed round. In our case, at the moment we think we may not need any additional investment after that initial round. However, let’s say that we find out that we are wrong and do need more money – perhaps to invest more in sales, marketing or additional product development. Let’s say we need US$ 2mm more to do that. Assuming we succeed in the subsequent funding round, and assuming no revenues yet, the company would then already be valued at US$ 6mm post-money valuation after this second round is completed. Dilution would occur and the initial seed investor share percent would go from 25% to 16.67%. The founder share percent would also be reduced and diluted. At the end of the day, even if I started out with 75% of one million and end up with 2% of US$ 10bn, I would be very happy. So, while dilution is, well dilution, a smaller percentage of something big can be better than a large percentage of something small.

Option Pools and Advisors

In calculating the share capital of your start-up, it is always a good idea to leave room in for option pools as well as for advisors. In order to attract top talent, you will want to be able to give them shares in the company. As many start-ups operate on a shoe string budget and are not able to pay massive salaries or benefits, offering key talent an upside in your company can go a long way to helping unleash their passion to help make the company and whole team successful. In addition to option pools for employees you will also want to keep some reserved for key folks, well connected individuals, industry thought leaders, that you may want to bring on as your board of advisors (BOA) or non-executive directors (NEDs). Typical amounts for a board of advisor role would be 0.5% to 1%. As with the initial founders and seed investors, these amounts also get diluted with each additional funding round.

If you just google “equity model calculator” you will find a lot of results on the web along with sites that generate fancy charts. However, save yourself a ton of time. Most of these sites are not so clear and kind of clunky to customize the model if you want. We have done the work and found one that answered all of our questions. In addition, it even provided a template we could customize to our specific situation. This link is shared below. Attention – just one slight thing was missing, the model does not contain entries for BOA or NED amounts, or at least it did not when we used it, however, you can easily add those in yourself just as we did.

Tool for calculating your equity cap table and post money dilution effects:

http://thedrawingboard.me/2013/11/10/model-cap-table/

Link to the Model Cap Table: http://bit.ly/1ayKk8p

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