Startup valuation – data you need, tips you can use when grocking it.

There are new data out on “pre-money” startup valuations, and it indicates that now is the time to raise money if your young company needs it. Why? Because “pre-money” valuations of startups — the base line value used by VCs to determine the smallest amount of money they need to put into a new company to get the equity stake they want in it — are higher than they’ve been since the first quarter of 2001, a.k.a the last gasp of the dotcom bubble. The median valuation of companies seeking an initial round of professional money is now $8.7 million, according to a joint report issued by Dow Jones and Ernst & Young. Our friends at VentureBeat digest the data nicely here, and offer a few important caveats:

…”valuations can fluctuate significantly, and its difficult to tell how long the relative high will last. Note how value dropped to $5.4 million during the first quarter.”

And: “the credit crunch, and continued woes in the housing sector appear to be a drag on the economy, and this could impact public stocks, which in turn affects the values of private companies.”

But what CAN this mean for you right now? If you get to it, it could mean more cash in the coffers for less flesh out of the hide!

But before you dust off that b-plan and suffer a VC parade, we suggest you check in again with our friends at Inc. magazine, for columnist Michael Lechter’s tips-filled essay on fundraising called, “Timing is Everything:”

How much money you raise and when you raise it should be viewed relative to both the stage of development of your business and condition of the market…On the other hand, it may not be large enough to interest various professional investors, i.e., venture capitalists.

Pay special attention to Lechter’s sidebar entitled “Putting Equity Investment Into Perspective,” where he offers some easy back-of-the-envelop calculations to illustrate his points:

Here’s a quick scenario that helps put into perspective the decision to take on equity investors for particular milestones versus a heftier, less directed investment that serves the general growth of your business.

First, let’s assume that the present value of your company is $100,000, and you need $400,000 to bring the company to the point where it is cash flow positive. If you bring in $400,000 of equity investment at this point, you would be left with only a 20% equity interest in the company (Your contribution to the venture would be $100,000 — the pre-investment [“pre-money”] value of the company — against the investors $400,000). In other words, the cost of the equity money would be 80% of your company.

Now let’s assume that you identify a specific milestone that would cause significant appreciation in the valuation of your business — e.g., completing a prototype. [Lechter surmises that] at a cost of $20,000, this prototype has the potential to increase the value of your company from $100,000 to $300,000…Your contribution to the “co-venture” is $100,000, against the investor’s $20,000, leaving you with an 80% equity interest.
…[Then] you raise the remainder of the $400,000 after completing the prototype. The value of the company is now $300,000 [and now] 80% of [the equity] is attributable to you, against the new investor’s $380,000 (leaving you with approximately 35% of the equity). If you could self-fund or obtain a loan for the $20,000 necessary to get to the point of obtaining the [first round], so much the better. (You would retain approximately 44% of the company).

So, if you don’t need $8 million or $9 million now, your founder’s interest may be better-served if you take out a commerical loan and skip the VCs altogether — even if the pro-money is cheap right now. Why give up equity if you don’t have to?

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