How VC Funding Works: What is your Valuation | TFJ E66

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welcome to the founders Journey podcast

inspiration education for Founders by

Founders hey Greg Moran here from

Evergreen Mountain Equity partners and

uh Evergreen growth in the founders

Journey podcast if you’re a startup

founder you’re looking to raise venture

capital or you simply just maybe you’re

an LP or potential LP meaning an

investor in a venture capital firm and

just want to understand how VC funding

actually works you’re in the right place

we’re going to talk a little bit about

how to break down your company’s startup

valuation and why it’s really critical

for your startup Journey this is a

really uh tricky topic I know over the

years I’ve struggled with this myself as

a Founder because it’s easy to really

undervalue yourself but it’s also really

easy to overvalue yourself and kind of

finding that right balance is a really

really tricky thing so we’re going to

talk about that a little bit today so

first want to take a quick look at the

venture Capital funding process itself

VC funding typically starts with smaller

rounds may not even be a VC a lot of

times we hear the term friends and

family and that’s exactly what it sounds

like Angel Investors you may have heard

that those are usually individual

investors that start that invest in

private companies and it starts with

smaller rounds like a seed round or even

a preed round you may have heard uh that

term before and really what that means

it’s it’s really early stage and

typically from there you move on to a

series a round series a is just like

kind of the starter round for VCS to

start to scale the company we’ll talk

about that more in other videos as well

and a lot of times you’ll progress

through kind of the alphabet soup of

funding series b c so on sometimes

living here D things like that at each

stage this your your valuation really

plays a key role in determining how much

money you’re going to need to give up as

the founder in exchange for that

investment and it’s a really interesting

thing because if your business really

starts to grow in scale it can mean

millions or tens of millions or hundreds

of millions of dollars in long-term

wealth creation for you down the road so

this is an important thing to really

understand so when we say the term

valuation and simple terms it’s the

estimated worth of your company so this

can either be determined before or after

a funding round so those two terms are

known as pre-money and post-money

valuation so let me break that down

further because that can be a little bit

complicated simply pre-money valuation

really refers to the value of your

startup before any investment is added

okay so if I believe my company is worth

$10 million today and nobody’s invested

it’s worth $10 million that’s my

pre-money

valuation post money on the other hand

is the value after the startup after the

investment has been made so quick

formula for this is really pre-money

valuation plus investment equals

post-money valuation so just to give a

really quick example in that scenario

where I thought my company was worth 10

million and maybe somebody invest two

million into my company and agrees with

me that it’s worth 10 million my post

money valuation is 10 million pre money

plus the investment 2 million post money

12 million okay so we’ll talk about why

that’s really important to why those two

things become really important because

they really uh they really have a lot to

do with the equity distribution there’s

a lot of factors that that influence

your startups valuation this can include

market trends financial performance

strength of the team is a big one

product development competition all of

these things are are what I as an

investor and any investor really look at

to gauge the potential long-term success

of your business because ultimately as

an investor that’s what I’m betting on

the long-term potential of your business

there are very few shortterm gains to be

had in the Venture Capital world so

there are a few ways to calculate your

valuation these are really you can

really go down the rabbit hole here so I

would try to understand these but I’m

GNA tell you right now make sure you’ve

got a really strong financial adviser an

accountant who’s done private Equity

type Venture Capital deals before and a

great account and a great lawyer these

are not things to skimp on that do not

go with a lawyer who you know

represented you in the purchase of your

house or you know or got you out of a

traffic ticket you want to go with

lawyers and accountants advisers here

who really understand because a small

mistake upfront can cost you millions in

the long run don’t be cheap here so now

I’ll get into it a little bit so the

there’s really kind of a lot of

ways uh to value a company investors

will use to value a company some of the

most common ones there’s really kind of

three really common ones you’ll hear

different names for these sometimes

first is discounted cash flow and that

means it’s it really what it’s doing is

it’s estimating the future cash flow of

your business and then discounting it to

the present value there’s a lot of

formulas for doing this it can be really

complicated calculations but it’s

basically how much money do we believe

how much cash do we believe your

business will throw off in the future

and then we kind of bring that back and

say okay what’s that what’s the value of

that for me worth today because it’s

going to be worth less for me today than

when it’s actually realized in the

future because there’s risk right may

not ever get realized second one uh

that’s fairly common is a comparable

company analysis and what that means is

you’re really comparing your startup to

other companies in the market now you

see this a lot in in hot markets where

there uh are there’s a lot of

competition for deals you’re seeing this

today in AI some other sectors climate

Tech you’re seeing this as well um so

when you have other similar companies

that are similar size you can look at

the valuations of those companies and

say okay what’s the market paying uh for

those companies today what are investors

paying how do they value you know for

based on the similar size similar space

and then the third is what we call the

Venture Capital method right not very

scientific way you know not very

scientific name but really what you’re

doing is you’re estimating the long-term

exit value and then you’re working

backward to determine the current value

okay so if we believe that the long-term

value on a company is going to be a

billion dollars because there’s this

massively growing Market there’s huge

macro Tailwinds the timing is perfect

we’re going to pay more for that as a

venture investment that may be something

that is a great business but maybe it it

doesn’t have those kind of macro

Tailwinds behind it right um you know

again AI is a good example of this you

see Venture Capital firms paying really

high rates because there’s a there’s a a

ton of Market momentum behind them and

there’s a belief that the exit values

can be really really strong where and

then they’ll work back and they’ll pay

more today for that long-term potential

whereas you know in other areas you may

not may not have quite that kind of

long-term potential quite honestly I’ve

always started businesses that were not

the hot companies uh in the space I

spent my career in HR technology and

sales technology and you know these were

good spaces these were really good

markets but you know the long-term exit

value probably wasn’t as high as other

areas where you know like fintech or

climatech or AI or something like that

are today right so company you know so

VCS were willing to pay less that was

okay for me right and it doesn’t you

don’t have to be in the hot space so but

understanding that long-term exit value

and then working back is that Venture

Capital method which is really that kind

of third common method again you’ll hear

different terms each method has its pros

and cons um the one that’s right for you

is going to depend on your specific

situation again advisors will help you

understand this VCS again will kind of

help guide you in this area as well

because ultimately your start of

valuation is what an investor is willing

to pay for right just like anything else

in life so your your valuation is really

critical because it directly impacts how

much Equity you have to give an exchange

confed investment so give you an example

you have a pre-money valuation let’s say

your pre-money valuation is 5 million

okay and you go out and you raise a

million dollars again let’s go back to

that formula pre-money five investment

one pre-money plus investment equals

post money six right what that means is

that the investor is going to receive

about

16.7% equity in your

company one

/ six right that’s how you’re determined

that’s that’s the equity because the the

percentage now you could the the common

mistake people will make is to say well

I’m giving up 20% one divided by five my

pre money no you’re giving up the

investment divided by the post money is

the actual Equity delusion that’s taking

place important to understand these

things so when you’re negotiating your

valuation you you can negotiate the

things right because little changes can

make a big difference that five million

pre money if you could negotiate six for

that million makes a big difference you

know 1% can mean an awful lot in the

long-term equity in the long-term value

of your company so you can negotiate

these things um and when you’re

negotiating that valuation with

investors you really want to keep a few

things in mind right number one know

your worth be confident in your business

and potential

but number two you got to be able to

back that up right so use data use

projections but also understand what the

market is paying for similar kind of

companies again I talked about those

three valuation

methods if you really want to get

technical about it you can try to figure

out what you think you might be worth on

a discounted cash flow but if you just

use the other two simple method methods

what what are Market comps in your space

for your size company and what do you

believe the loan longterm exit value be

realistic here right the chances that

you’re going to build a multi-billion

dollar company not saying it’s

impossible but it’s probably unlikely

compared to your ability to say build

100 or $200 million dollar company right

be realistic you want to shoot for the

moon have high expectations but you do

want to be realistic and be able to back

up your notion of what you believe you

you you’re worth today and then really

be open to feedback is the other tip

I’ve seen Founders enter into these

things and say I’m worth a hundred

million and that’s it and I’m not taking

a penny less and you know what ends up

happening they don’t raise

money that’s a problem or they just lose

credibility right investors may have a

very different perspective so be open to

adjusting your valuation based on the

input that you’re hearing from the

market don’t be so rigid in your stance

that you can’t grow your company because

you can’t get the money raised that

doesn’t do any any good right so be

realistic back it up know your worth and

then be open to the feedback you’re

getting from the market so

valuation it’s a really critical step

it’s a really critical part of the

funding process getting it right can

make all the difference in your

long-term fundraising success and more

importantly your long-term growth of the

company so if you found this video

helpful give it a thumbs up share it

with other entrepreneurs that are

thinking about the VC world or maybe

other maybe you’re other people that are

thinking about making investments in

Venture Capital firms firms don’t forget

to subscribe to this podcast channel uh

for more insights in venture capital and

uh and business growth I’m Greg Moran

from Evergreen Mountain Equity partners

and Evergreen growth uh appreciate you

joining me today we’ll see you next time