Determining your startup’s valuation is one of the more difficult tasks you’ll face as a founder.
Getting it right can set the stage for successful fundraising rounds and exits. Getting it wrong can cost you equity and diminish future capital investments — and in some cases it could lead your startup to fail.
Assessing the value of your company is both an art and a science, which can make the process downright confusing and leave you feeling uncertain about a highly visible KPI. Wouldn’t you rather focus on running your business?
Thought so. We did the heavy lifting and put everything you need to know about how to value your startup into this Valuation Quick Guide. It’s an easy-to-follow resource for SaaS founders that covers:
How Startup Valuation Works
It's helpful to take a step back and consider what valuations mean. A startup valuation is essentially the basis for an investment decision — an agreement between you and your investors on what your business is worth. It’s a lot like determining the value of a house.
The best startup investors use company valuations to balance risk vs. return. Some investors consider a high valuation a greater risk; others feel a higher valuation means a lower risk. Most will use business KPIs and some valuation methods to determine your company’s potential for success.
Ultimately, the market value of your startup will come down to a negotiation and an agreement between you and your investors. So consider any independent valuation calculation a jumping-off point for establishing your company’s value at each funding stage.
These tips can help you stay flexible and manage expectations during negotiation:
Don’t let your company valuation stop you from reaching an agreement with a potential investor.
Pick your battles wisely, and play your cards right for long-term success: Gauge their level of interest and leverage demand from other investors who may want in on your deal.
You may get a higher valuation pre-revenue, since there isn’t yet much that is measurable. (These valuations are much more subjective.)
Higher valuations aren’t always better; we explain why in the next section.
Pre-money and post-money valuations explained
Valuations can change significantly depending on your stage in the startup journey. A fundraising event will greatly impact your startup’s market value, either positively or negatively. The valuation calculations before and after these events are different, so it’s important for founders to explore both pre-money and post-money valuations when negotiating an investment agreement.
Let’s look at how pre-money and post-money valuations differ and how to use them strategically when raising funds.
What is a pre-money valuation?
A pre-money valuation is the value of a company before a funding round and typically determines what an investor’s shares in the company are worth. In other words, it’s a company's equity value before receiving capital from an investor in an upcoming round.
What is a post-money valuation?
A post-money valuation is the pre-money valuation plus the cash coming in from the new round of investment. For example, you raise $1 million in your series A round and your negotiations result in a pre-money valuation of $5 million. Your post-money valuation is $6 million.
How are pre and post-money valuations different?
Put simply, one includes the new capital investment from a raise, and one does not. However, you’ll want to consider both valuations and the equity stake in the deal and how they might impact your strategic growth in the future.
Expanding on the previous example, let’s say you have a choice between two investment offers:
$1 million funding for 20% equity in your company and a pre-money valuation of $5 million
$1 million funding for 12.5% equity in your company and a pre-money valuation of $8 million
At first glance, this seems like an easy decision — take the higher valuation and give up less equity. Yet each of these deals yields a different post-money valuation, each setting a different bar for future fundraising rounds:
If you take Offer 1, you’re looking at a post-money valuation of $6 million; Offer 2 gives you a post-money valuation of $9 million. Even though you’ll raise the same amount of money with both deals ($1 million), you’ll be expected to earn a valuation that’s $3 million more going into your next round of financing if you take Offer 2. Missing that target is considered a “down round,” which can threaten the success of your business. More on that shortly.
Why Valuing Early-Stage Startups is Challenging
Established businesses have assets, financial history, a loyal customer base, and (hopefully) profits. This makes it fairly straightforward to model a company’s worth. On the other hand, startups may be missing some or all of these depending on their stage, but they could have the potential for high growth, which might also be accelerated by market demand.
Combine both past and future uncertainty with outside capital and equity investments, and you can see how complex a company valuation becomes.
We break down five common characteristics of early-stage startups that make valuation challenging:
1. Limited historical data
Investors can't rely on business forecasts without years of financial and operational data. Forecasts are still important for managing your business, but investors will instead look to outside market data that show comparable though imperfect trends.
2. Little or no revenue
It’s easier for new technology businesses to start generating revenue today than a few years ago. However, startups still struggle with churn and new customer acquisition once they have a product in the market, which makes for an unpredictable revenue stream. Future profitability is even harder to predict.
3. Illiquid investments
Equity investments in private startups aren’t as liquid as investments in profitable or publicly traded companies. In other words, money invested in a startup can’t be as easily converted into cash. Illiquidity creates a riskier investment without an easy exit. Investors tend to put a premium on liquidity and will factor it into what they believe a company is worth.
4. Equity dilution
As startups gain investors and funding, equity gets divided up and reduced (diluted) through new shares issued to those who now have an ownership stake in the company. Generally speaking, the more funding rounds a startup has been through, the greater its equity dilution. New investors will likely try to minimize valuation in later funding rounds to get a bigger slice of the company. To complicate things, equity claims or rights issued to investors can vary greatly and make it hard to figure out ownership percentages.
5. Risk of failure
Though we’re far more likely to hear about unicorns and big winners, the reality is that only a fraction of startups makes successful exits. More than two-thirds never deliver positive returns to investors. Younger startups, in particular, have a higher probability of failure.
The threat of down rounds
In a down round, a startup’s pre-money valuation is less than its post-money valuation from the previous fundraising round. Generally, founders try to avoid down rounds.
The perception of a down round is that your business did not meet expectations, making it harder to secure the funding you need at a favorable valuation down the road. As mentioned earlier, when you agree to a valuation that’s too high in a previous round (often in exchange for retaining more ownership of your business), it can easily cost you more equity than you saved when you took the higher valuation.
Of course, many variables can lead to a down round, including unpredictable macroeconomic conditions outside any founder’s control.
Early-stage VC valuations on the decline
Publicly traded SaaS and other technology companies’ valuations have fluctuated dramatically in recent years, and following the collapse in high-growth tech stocks this past summer, it may be too soon to tell if we are starting to see a floor for SaaS valuations.
Although many headlines are telling startups to expect the hardest fundraising climate in more than a decade, some feel the market reset creates opportunity: Thoma Bravos' $10.7 billion take private of Anaplan at around 16X trailing twelve-month (TTM) revenue, and Vista Equity’s $8.4 billion take private of Avalara at around 9X TTM revenue are two examples.
With interest rates also in flux, it appears investors are now favoring companies that can generate near-term cash versus further-out growth, as seen below:
So what happens if capital continues to be expensive? Read our take on this new environment:
How to Value Your SaaS Startup
It’s always good to know what your startup is worth, whether you are looking to raise your first round of funding or are about to exit.
It’s also important to remember that determining your valuation is far more subjective than objective; if you feel it’s not very methodical, you’re right. This is especially true if you’re at an earlier stage or pre-revenue, where valuations are erratic and greatly influenced by current market sentiment.
Different industries use different indicators to estimate the value of a startup business.
Here’s where there’s good news for SaaS founders…
Revenue and earnings KPIs are good predictors of what your business is worth, and customer-focused KPIs provide solid justification for SaaS or subscription-based business valuations because they paint a clear picture of the health of your business.
The following chart shows eight crucial SaaS metrics that can help you determine the value of your company business's reliance and let you keep a finger on the pulse of your business.
KPIs for SaaS Startup Valuations
The cost of acquiring new customers is the best way to determine a SaaS company's ability to become profitable, because it shows how much it costs to generate new revenue.
Similar to recurring revenue but includes new bookings that have not yet been recorded as revenue. It’s a better gauge of the current health of your business since it captures what the business achieved in the given quarter.
Revenue Growth Rate
This one is pretty simple — the percentage by which your revenue has grown period-over-period. This metric speaks to how the business is able to scale.