Valuation
When you get investment from a venture capitalist, that VC will determine a valuation, or, more precisely, a "pre-money valuation". In other words, the VC will determine what your company, as it exists today, is worth. That valuation determines what percent of your company the VC purchases for the money he or she invests. For example, if your pre-money valuation is $4 million, and the VC invests $4 million, then your post-money valuation is $8 million, and the VC owns half the stock.
How does a VC come up with a valuation? It's part art and part science. For a summary of the theoretical approaches to valuing a startup, see the student papers on the OGI Capstone Resources page (see Websites).
The Question of Control
One issue that often worries entrepreneurs is that if they sell 50% or more of the stock in their company, then they lose control. We'd like to suggest that control is probably not the right thing to worry about.
If you seriously need the VC's money, then the VC has the leverage to negotiate significant control, regardless of the percent of stock ownership. For example, they generally dictate the structure of the Board of Directors, which certainly conveys significant control. And they generally require a veto on major actions such as acquisitions. Perhaps the most significant control is that you will likely need more money in the future, and they control the purse-strings. That's a lot of control.
The good news is that most VCs understand that the management team and, for that matter, all employees need to be motivated. Employees need to own a major share of the company, or there will simply not be enough potential pay-off to justify the great amount of effort required. In each investment round, the VCs should be willing to add to the option pool, and add to options that have already been granted, to make sure that employees remain motivated.
How to Increase your Valuation
To maximize our valuation, you can:
- Make as much headway in your business (developing product, getting revenue, etc.) before asking for venture funding
- Make sure that your market opportunity is large enough to justify VC interest
- Choosing a hot market doesn't hurt; if there's lots of investment in your market, and your company offers a differentiated opportunity, it bodes well for your valuation
- Competition: if multiple VCs want to lead your round, than you have demand and supply working for you.
- Build the strongest management team you possibly can. A strong team will increase your valuation.