If you’re a first-time founder looking to raise an institutional round of venture capital for the first time, how do you know where to start?
How does one know how much to raise or where their valuation lies? It’s a position many startup founders will find themselves in within their first few years. It’s also a task every venture capitalist will probably approach differently.
Top of mind right now: We’re still in or maybe soon exiting a period of very high and competitive valuations.
Watch the sizzle
At the start of the year, software startups were fetching valuations at or significantly above 100 times their annualized revenue, PitchBook reported. Compare that to 2021, when median late-stage VC valuation in the US was about 20x revenue, up from 10.9x revenue in 2020.
But overvaluations and “following the sizzle” can get companies and their investors in trouble, said Kimberly Klayman, a partner-elect at Ballard Spahr, at a venture capital event hosted by the law firm last week.
If everyone’s standing in line to invest in a company, do you want to get in line?
The secret to VC, he said, is that the best venture funds are still wrong a lot of time. He noted a recent study that found a certain fund’s most successful deals were ones that didn’t have full agreement of the partnership when they went in. The smash hit deals weren’t obvious.
“You think you’re going to go all the way to exit on sizzle?” she said. “It’s a scary basis for a decision.”
Common numbers suggest that investors will have between 15 to 30% stake in a company — but every deal is a negotiation, panelists agreed.
Hartt said that the org runs audits and applies multiple financial methods to a proposed valuation before deciding to make a deal. Startups in the healthcare space can be unique, she said.
“We’re often working backward. In healthcare, there’s not the simple supply and demand relationship with commercialization as in other sectors — no simple, clean market dynamics,” Hartt said. “We always have to look at who is going to pay and why, and there’s a long R&D period. We’re almost working backward from that, and methodology can become a circular problem. If you’re benchmarking against already high benchmarks, that can be a problem.”
Topche said his firm does have a scientific way to figure out valuations. But the fund, which is focused on Penn startups, also aims to ensure founders maintain enough of their company after a VC round.
Advice for founders
When it comes to setting your valuation and raising a round, angel investor Katherine O’Neill’s advice is to go into it with some confidence and the evidence to back you up, but to be flexible. Founders can look to similar raises or valuations in their market, but overall, they have to sell the investors on where the company can go.
Hartt encouraged founders to drive the discussion with investors with financial modeling and company projections. And while it’s somewhat of a guessing game to the best of a founders’ abilities, it shouldn’t be a full shot in the dark.
“You should know what you want your valuation to be,” O’Neill said. “I find that a lot of founders ask what their valuation is, and it is good to test with us, but the decision-making tree should come back to the plan for the company. How do you envision equity over time?”