Calculating Pre-Money Valuation for Startup
"Since you have no sales, I'd likely question how well could you determine the value of the company's assets in a reasonable fashion. You may be better to estimate sales and discount that back to a current valuation. For example, insurance companies could determine that if you wanted to be paid $x/month for the rest of your life, the present day value of that is $y. There are similar mechanisms for businesses but this does get tricky as the estimates have to be somewhat conservative and you have to be prepared for some other scenarios. For example, if you got the $200,000 then would you really never have to ask for more external equity financing in the future or is it quite likely that you'd want another infusion down the road? While you can mark it at $1,000,000 there will be questions about why that value that you'd have to answer and saying, ""Cause I like big round numbers,"" may not go over well. My suggestion is to consider what kind of sales will the company have over the next 5 years that you could work back to determine a current price. If you believe the company can have $5,000,000 in sales over the 5 years then it may make sense to place the current valuation of $1,000,000 on it. I wouldn't look too much into the money and time you've invested as that isn't likely to go over well with investors that just because you've put in what is worth $x, the business may or may not be worth that. The challenge is that without sales, it is quite difficult to get an idea of what is the company worth. If it makes billions, then it is worth a lot more than a company that never turns a profit. Another way to consider this is the question of what kind of economic output do you think you could do working here for the next 5 years? Could you do thousands of dollars of work, millions of dollars or just a few bucks? Consider how you want this to be seen where if you want some help look up episodes of TV shows like ""Dragon's Den"" or ""Shark Tank"" as these give valuations often as part of the pitch which is what you are doing." The value of a business without proven profits is really just a guess.  But to determine what % ownership the VC takes some measure must be used.  He is asking the OP to start the negotiations.  So you start high - higher than you will settle for. The value of the business should always be WAY more the $$ you have put into it ... because you have also invested your time (which has an opportunity cost) and assumed huge risk that you will never get those $$ back.   When you need the cash and only one person will give it to you, you are over a barrel.  You either take the terms they offer, or you let the business collapse.  So keep a show of strength and invent other funders. Or create a business plan showing that you can continue without their $$ (just at a smaller volume). "Putting a dollar amount on the valuation of a start up business is an art form that often has very little at all to do with any real numbers and more to do with your ""salesman"" abilities when talking with the VC. That said, there are a few starting points: First is past sales, the cost of those sales and a (hopefully) realistic growth curve.  However, you don't have that so this gets harder. Do you have any actual assets?  Machinery, computers, desks, patents, etc.  Things that you actually own.  If so, then add those in.  If this is a software start-up, ""code"" is an asset, but without sales it's incredibly hard to put a value on it.  The best I've come up with is ""How much would it cost for someone else to build it .. after they've seen yours"".  Yes, you may have spent 5,000 hours building something but could someone else duplicate it, or at least the major parts, in 200 hours after seeing a demo?  Use the lower number. If I was you, I'd look hard at my business plan.  Hopefully you were as honest as you can be when writing it (and that it is as researched as possible).  What is it going to take to get that first sale?  What do you actually need to get there? (hint: your logo on the side of a building is NOT a necessary expense.  Nor is really nice office space.)  Once you have that first sale, what is the second going to take?  Can you extrapolate out to 3 years?  How many key members are there?  How much is their contribution worth?  At what point will you be profitable?   Next is to look at risks.  You haven't done this before, that's huge - I'm assuming simply because you asked this question.  Another is competitors - hopefully they already exist because opening a new market is incredibly hard and expensive; on the flip side, hopefully there aren't that many because entering a crowded market is equally hard and expensive.  Note: each are possible, but take radically different approaches and sums of money - and $200k isn't going to cut it no matter what it is you are selling. That said, competition should be able to at least point you in the direction of a price point and estimate for how long sales take.  If any are publicly traded then you have additional info to help you set a valuation.  Are there any potential regulatory or legal issues? What happens if a key member leaves, dies or is otherwise no longer available?  Insurance only helps so much if the one guy that knows everything literally gets run over.  God help you if this person likes to go skydiving. I bring risks up because you will have to surmount them during this negotiation.  For example, asking for $200k with zero hard assets, while trying to sell software to government agencies assuming a 3 week sales cycle will have you laughed at for naivety.  Whereas asking for $10m in the same situation, with a team that has governmental sales experience would likely work. Another big question is exit strategy: do you intend to IPO or sell to a competitor or a business in a related category?  If selling, do you have evidence that the target company actually buys others, and if so, how did those deals work out?  What did they look for in order to buy?  Exit strategy is HUGE to a VC and they will want to make several multiples of their money back in a relatively short amount of time.  Can you realistically support that for how much you are asking for?  If not then going through an Angel group would be better.  They have similar questions, but very different expectations. The main thing is that no one knows what your business is worth because it is 100% unproven after 2 years and is therefore a huge financial risk.  If the money you are asking for is to complete product development then that risk factor just went up radically as you aren't even talking about sales.  If the money is purely for the sales channel, then it's likely not enough. However if you know what it's going to take to get that first sale and have at least an educated idea on how much it's going to cost to repeat that then you should have an idea for how much money you want.  From there you need to decide how much of the business it is worth to you to give up in order to get that money and, voila, you have a ""pre money valuation"". The real trick will be to convince the VC that you are right (which takes research and a rock solid presentation) and negotiating from there.  No matter what offer a small percentage of the business for the money you want and realize you'll likely give up much more than that. A few things you should know: usually by year 3 it's apparent if a start-up is going to work out or not.  You're in year 2 with no sales. That doesn't look good unless you are building a physical product, have a competent team with hard experience doing this, have patents (at least filed), a proven test product, and (hopefully) have a few pre-orders and just need cash to deliver.  Although in that situation, I'd probably tell you to ask your friends and family before talking to a VC.  Even kickstarter.com would be better.   $200k just isn't a lot of money and should be very easy to raise from Friends or Angels.  If you can't then that speaks volumes to an institutional VC.  A plus is having two or three people financially invested in the company; more than that is sometimes a problem while having only 1 is a red flag. If it's a web thing and you've been doing this for 2 years with zero sales and still need another $200k to complete it then I'd say you need to take a hard look at what you've built and take it to market right now.  If you can't do that, then I'd say it might be time to abandon this idea and move on as you'll likely have to give up 80%+ to get that $200k and most VCs I've run into wouldn't bother at that level.  Which begs the question: how did the conversation with the VC start?  Did you approach them or did they approach you?  If the latter, how did they even find out about you?  Do they actually know anything about you or is this a fishing expedition?  If the latter, then this is probably a complete waste of your time. The above is only a rough guide because at the end of the day something is only worth what someone else is willing to pay.  $200k in cash is a tiny sum for most VCs, so without more information I have no clue why one would be interested in you. I put a number of hard questions and statements in here.  I don't actually want you to answer me, those are for you to think about.  Also, none of this shouldn't be taken as a discouragement, rather it should shock you into a realistic viewpoint and, hopefully, help you understand how others are going to see your baby.   If the VC has done a bit of research and is actually interested in investing then they will bring up all the same things (and likely more) in order to convince you to give up a very large part of it.  The question you have to ask yourself is: is it worth it?  Sometimes it is, often it's not." "When the VC is asking what your Pre-Money Valuation is, he's asking what percentage of shares his $200,000 will buy. If you say your company is worth $800K, then after he puts the money in, it will be worth $1M, and he will own 20% of all shares – you'll still own the remainder. So when the VC is asking for a valuation, what he really wants to know is how much of your company he's going to own after he funds you.  Determining your pre-money valuation, then, is a question of negotiation: how much money will you need, how likely are you to require more money later (and thus dilute the VC's shares, or give up more of your own shares), how likely is your business to survive, and how much money will it make if it does survive? It isn't about the actual value of your business right now, as much as it is ""how much work has gone into this, and how successful can it be?"" The value is going to be a bit higher than you expect, because the work is already done and you can get to market faster than someone else who hasn't started yet. VCs are often looking for long shots – they'll invest in 10 companies, and expect 7 to fail, 2 to be barely-profitable, and the last one to make hilarious amounts of money. A VC doesn't necessarily want 51% of your company (you'll probably lose motivation if you're not in charge), but they'll want as much as they can get otherwise."
You will probably never see it.  The startup at some point may start issuing dividends to the shareholders (which would be the owners, including you if you are in fact getting equity), but that day may never come.  If they hire others with this method, you'll likely lose even that 5% as more shares are created.  Think of inflation that happens when government just prints more money.  All notes effectively lose value. I wouldn't invest either, most startups fail. Don't work for free on the vague promise of some future compensation; you want a salary and benefits.  Equity doesn't put food on your table. Relative valuation is always my go to. Reason being i can make any company a buy or sell by changing assumptions such as growth rate, discount rate ect with a DCF. Still a great exercise to complete on all investments. Also an RV will help you pick the best out of the group (hopefully) rather than take  a stance on whether you can actually predict the future inputs ( no one can) "Will the investment bank evaluate the worth of my company more than or less than 50 crs. Assuming the salvage value of the assets of 50 crs (meaning that's what you could sell them for to someone else), that would be the minimum value of your company (less any outstanding debts). There are many ways to calculate the ""value"" of a company, but the most common one is to look at the future potential for generating cash.   The underwriters will look at what your current cash flow projections are, and what they will be when you invest the proceeds from the public offering back into the company.  That will then be used to determine the total value of the company, and in turn the value of the portion that you are taking public. And what will be the owner’s share in the resulting public company? That's completely up to you.  You're essentially selling a part of the company in order to bring cash in, presumably to invest in assets that will generate more cash in the future.  If you want to keep complete control of the company, then you'll want to sell less than 50% of the company, otherwise you can sell as much or as little as you want." Ok so I used Excel solver for this but it's on the right track.  Latest price = $77.19  Latest div = $1.50  3-yr div growth = 28%  g = ???  rs = 14%  So we'll grow out the dividend 3 years @ 28%, and then capitalize them into perpetuity using a cap rate of [rs - g], and take the NPV using the rs of 14%. We can set it up and then solve g assuming an NPV of the current share price of $77.19.  So it should be:  NPV = $77.19 =   [$1.50 / (1+0.14)^0 ] +  [$1.50 x (1+0.28)^1 / (1+0.14)^1 ] +  ... +  [$1.50 x (1+0.28)^3 / (1+0.14)^3 ] +  [$1.50 x (1+0.28)^3 x (1+g) / (0.14-g) / (1+0.14)^4 ]  Which gives an implied g of a little under 9%. Let me know if this makes sense, and definitely check the work... You are wildly over-estimating your taxes.  First, remember that your business expenses reduce your gross income.  Second, remember that taxes are progressive, so your flat 35% only applies if you're already making a high salary that pushed you into the higher brackets of US and CA. I think the deeper problems are: 1) you are expecting a super early start-up (with no finished product) to pay you the same as a steady job, including health insurance, and 2) you are expecting Kickstarter to independently fund the venture. The best source of funding is yourself.  If you believe in this venture and in your game design abilities, then pay for most of the costs out of your own savings.  Cut your expenses to the extent you can. You may want to wander over to startups.SE to get more perspective and ideas on your business plan. "There are some assumptions which can be made in terms of the flexibility you have - I will start with the least flexible assumption and then move to more flexible assumptions. If you must put down a number 1, your go-to for this(""Change the start period to 1""), is pretty good, and it's used frequently for other divide-by-zero calculations like kda in a video game. The problem I have with '1' is that it doesn't allow you to handle various scales.  Some problems are dealt with in thousands, some in fractions, and some in hundreds of millions. Therefore, you should change the start period to the smallest significantly measurable number you could reasonably have. Here, that would take your example 0 and 896 and give you an increase of 89,500%. It's not a great result, but it's the best you can hope for if you have to put down a number,  and it allows you to keep some of the ""meaning in the change."" If you absolutely must put something This is the assumption that most answers have taken - you can put down a symbol, a number with a notation, empty space, etc, but there is going to be a label somewhere called 'Growth' that will exist. I generally agree with what I've seen, particularly the answers from Benjamin Cuninghma and Nath. For the sake of preservation - those answers can be summarized as putting 'N/A' or '-', possibly with a footnote and asterisk. If you can avoid the measurement entirely The root of your question is ""What do my manager and investors expect to see?"" I think it's valuable to dig even further to ""What do my manager and investors really want to know?"". They want to know the state of their investment. Growth is often a good measurement of that state, but in cases where you are starting from zero or negative, it just doesn't tell you the right information. In these situations, you should avoid % growth, and instead talk in absolute terms which mention the time frame or starting state. For example:" I am an instructor who teaches Financial Modeling courses to investment bankers in NYC. Looking at the model, I do not see anything wrong with it. There are just too many assumptions. I would rather use the Multiple Value for the Terminal Value calculation, but, it will not make any significant differences. Some more thoughts :  a) The author has used text book method for valuation, but, everyone improvises the text book method, hence, subjective evaluations.   b) Oil and Gas valuation is quite a deep subject and every time we create models, industry experts come and big time change the inputs. We have no indication that the model is tested by industry experts (O&amp;G Operations experts)  c) For matured companies like ARAMCO, I would prefer the DCF model as used and then parb (adjust) using comparables. I do not see that it has been done in the model.  d) In some cases, investment experts would rather use 3 stage DCF model (5 years, next 10 years, next 20 years or so). It makes the model pretty complex, but, provides more accuracy.  e) The revenue taken in the calculation is flat, instead, he should have taken the data from past 10 years and modeled the fluctuations.   f) One of the biggest challenges we have faced in this sector is the accounting method full cost of successful effort. High CAPEX only occurs in one of the methods and depending on the company's maturity level, people may use different methods. More on this method in this link -http://www.investopedia.com/articles/fundamental-analysis/08/oil-gas.asp  I am at wits to understand how the value will be more than 1 Trillion dollars in any case. It's been awhile since my last finance course, so school me here:  What is the market cap of a company actually supposed to represent? I get that it's the stock price X the # of shares, but what is that actually representing? Revenues? PV of all future revenues? PV of future cash flows?  In any case, good write up. Valuation of tech stocks is quite the gambit, and you've done a good job of dissecting it for a layman. "Working for a lot of startups, I have seen this cycle. Really it has little to do with making the IPO look good because of number of employees, and is more about making the IPO look good because of planning for the future. Many times an IPO is released, it will be valued at $1.00 (made up) and the market will soar and spike. Now stock shares are valued at $3.00. Great. Till after the dust settles a bit, and stocks are valued at $0.85.  This is ""normal"" and good.  It would be better if the stocks ended a little higher than their initial value, but... such is life.  Now the initial value of the stock is made up of basically the value of the company's assets, and employees are part of those assets and its earning power. They are also a liability, but that has less impact on initial value than assets. Sales right after IPO are based on how well a company will do. Part of that is growth. So it looks nicer to say: ""We have 500 employees and have been growing by 20% per month."" than to say ""We have 100 employees"". In other words, before IPO, employees may be hired to make the company look like it is growing. They may be hired because the budget is projected based on expected growth and expected valuation.  After IPO, you get a concrete number. You have your budget. It may be more than you thought, or it may be less. In our example, the real budget (from capital), is only 28% of the entire projected budget, and 85% of the initial value. It's time to make some budget cuts.  Also, normally, there is a period of adjustment, company wide, as a company goes from VC funding, ""here, have as much money as you want"", to ""real world"" funding, with stricter limits and less wiggle room." There is no right and wrong answer to this question. What you and your business partner perceive as Fair is the best way to split the ownership of the new venture.  First, regarding the two issues you have raised: Capital Contributions: The fact that you are contributing 90% of initial capital does not necessarily translate to 90% of equity. In my opinion, what is fair is that you transform your contributions into a loan for the company. The securitization of your contribution into a loan will make it easier to calculate your fair contribution and also compensate you for your risk by choosing whatever combination of interest income and equity you see suitable. For example, you might decide to split the company in half and consider your contributions a loan with 20%, 50% or 200%  annual interest.  Salary: It is common that co-founders of start-ups forgo their wages at the start of the company. I do not recommend that this forgone salary be compensated through equity because it is impossible to determine the suitable amount of equity to be paid. I suggest the translation of forgone wages into loans or preferred stocks in similar fashion to capital contribution Also, consider the following in deciding the best way to allocate equity between both of you and your partner Whose idea was it? Talk with you business partner how both of you value the inventor of the concept. In general, execution is more important but talking about how you both feel about it is good. Full-time vs. part-time: A person who works full time at the new venture should have more equity than the partner who is only a part-time helper. Control: It is important to talk about control and decision making of the company. You can separate the control and decision making of important decisions from ownership. You can also check the following article about this topic at http://www.forbes.com/sites/dailymuse/2012/04/05/what-every-founder-needs-to-know-about-equity/#726842f3668a So, the price-earnings ratio is price over earnings, easy enough. But obviously earnings are not static. In the case of a growing company, the earnings will be higher in the future. There will be extra earnings, above and beyond what the stock has right now. You should consider the future earnings in your estimate of what the company is worth now. One snag: Those extra earnings are future money. Future-money is an interesting thing, it's actually worth less than present-money- because of things like inflation, but also opportunity cost.  So if you bought $100 in money that you'll have 20 years from now, you'd expect to pay less than $100. (The US government can sell you that money. It's called a Series EE Savings Bond and it would cost you $50. I think. Don't quote me on that, though, ask the Treasury.) So you can't compare future money with present-money directly, and you can't just add those dollars to the earnings . You need to compute a discount. That's what discounted cash-flow analysis is about: figuring out the future cash flow, and then discounting the future figuring out what it's worth now. The actual way you use the discount rate in your formula is a little scarier than simple division, though, because it involves discounting each year's earnings (in this case, someone has asserted a discount of 11% a year, and five years of earnings growth of 10%). Wikipedia gives us the formula for the value of the future cash flow:  essentially adding all the future cash flows together, and then discounting them by a (compounded) rate. Please forgive me for not filling this formula out; I'm here for theory, not math. :) Hi all  Started my MBA studies recently. We have a simulation project and I've taken the VP Finance Role as I didn't have much experience in this and wanted to learn more. Unfortunately I don't have accounting until next semester, so I'm trying to make up the cap with my career experience so far as an engineer + youtube tutorials.   I built a discounted cashflow model. I'm trying to now determine the amount of loan to take in my first year of business. Basically the equity financing doesn't cover our first year capital expenditure, let alone any other costs.  My question is how do I determine what an appropriate loan amount is to take. My first thoughts are enough to cover my capital expenses + 1st half of the year operating expenses before I start seeing a revenue.   Right now my balance sheet would lead me to believe I have a 0.52 Debt Ratio and 1.23 Debt-to-Equity ratio. Is that ok? To calculate you take the Price and divide it by the Earnings, or by the Sales, or by the Free Cash Flow. Most of these calculations are done for you on a lot of finance sites if the data is available. Such sites as Yahoo Finance and Google Finance as well as my personal favorite: Morningstar The quant aspect '''''. This is the kind of math I was wondering if it existed, but now it sounds like it is much more  complex in reality then optimizing by evaluating different cost of capital. Thank you for sharing "For every buyer there is a seller. That rule refers to actual (historical) trades. It doesn't apply to ""wannabees."" Suppose there are buyers for 2,000 shares and sellers for only 1,000 at a given price, P. Some of those buyers will raise their ""bid"" (the indication of the price they are willing to pay) above P so that the sellers of the 1000 shares will fill their orders first  (""sold to the highest bidder""). The ones that don't do this will (probably) not get their orders filled. Suppose there are more sellers than buyers. Then some sellers will lower their ""offer"" price to attract buyers (and some sellers probably won't). At a low enough price, there will likely be a ""match"" between the total number of shares on sale, and shares on purchase orders."