HOW TO deal with your early stage valuation

In Fundraising by Sébastien FluryLeave a Comment

There is a recurrent question coming to me for really early stage startup, who haven’t incorporated: how do we get investors without giving the majority of shares in my startup from day one?

For people who already have gone through the process, or for experienced people, that seems easy and obvious (so you can skip it!). But it’s not. Rather than repeating again and again, I’d try here to explain how to deal with it.

If you incorporate your company as a SA/AG/Ltd with CHF 100’000.- (sorry for readers outside of Switzerland – but the mechanism is universal) and you only have CHF 50’000.- in your pocket, you need the remaining amount of cash (for simplicity, let’s avoid the fact that you could indeed incorporate with this amount. Or that you can bring real goods).

If someone invests 50k now in your project, he’ll get 50% of the startup, right? No. Forget your accounting lessons, just for a while. It could be right, but you usually have other mechanisms at work for startups. Did you already hear about valuation?

One franc (or € or $ or £) of capital isn’t necessary equivalent to one franc of cash. Yes, one is not equal to one! Again, more experienced founders already have dealt with agio (basically, the difference between the price the investors agree to buy your shares and the value written on your share (usually 1.-)).

When you’re incorporating, at least for web and mobile startups, you are often not starting from nothing. You’ve already invested some time to build a Minimum Viable Product, set up the strategy, find partners, etc. And invested some cash. And if you’ve already shipped your first product, you probably already have some users… And if you’re lucky (that is, you already have reached a kind of market fit), some customers (= paying users). Everything you’re bringing into the company has a value, which has to be determined. But how?

Here are some tips to find a valuation of your project you should consider:

  1. how many years/man of development have you already invested, without getting any salary? Take a reasonable wage (one you could get if you were employed) and multiply it by the number of months/years you’re working on the project: that give you a value on the work done until now;
  2. gather all bills you have paid for the project (patents, hosting, brand, logo, travel, events, etc.) and add them to point 1).

If you already have some customers, you could also try to estimate a really important metric: the “customer life time value” (= what’s the net profit you’ll make before your customer leave). But when you’re at a really early stage, it seems difficult to estimate (you can only set assumptions, as you don’t know if the users base you have will really pay for your service). You can integrate this value to the previous approximation. Or take it independently if it’s bigger.

Now you have an approximative realistic value of the project, but which doesn’t take into account the cash flow potential. Maybe have you heard about the Discounted Cash Flow methodology (or one of the kind) which allows you to bring future cash flows to time 0 (=now)? That’s a mathematic tool to assess the value of your project, but beware… it doesn’t make a lot of sense for a startup, because:

  1. Your potential future cash flow are just assumptions: a budget is a correct calculation done with wrong numbers!
  2. It is completely dependent of the discount rate (= interest rate) you take into account. Forget the standard ones used at business school. If you want to use this valuation method to talk with investors, you can improve your credibility by using a discount rate comprised between:
  • 70 & 80% if your startup has a working prototype
  • 50 & 60% if you have users (Beta users or in a small amount)
  • 30 & 40% if you have some paying customers.

Remember that even if your product seems (and really is) great, there is still a huge risk not to reach your objectives. Startup are risky, even if you have a wonderful idea, excellent execution and a smart team. Things can go wrong.


A realistic approach is to take the mean of the different valuation methods to have a good

estimate on the value of your startup. Afterwards, it’s all a matter of negotiation… and common usage, at least for professional investors: be aware that when you open your capital, you’ll share 10-40% of the company for each round of funding (almost funding round amount agnostic!). If an investor would get the majority of the company with his investment, he doesn’t have understood the dynamics of startup. So run away!

You can use all the methods you want, but there’s no right valuation. The correct price is the one that investors are OK to pay.

But let’s do a practical example:

  • you’re 2 cofounders working without any salary for 12 months. As an employee, you could get each 6k a month. So the value of your work would be 144k (you could also do another calculation if you estimate with consulting hourly fee, which would be massively higher);
  • you’ve spent 30k (for travel, hosting, computer, etc. – I assume you don’t have an office as a bootstrapped startup!)
  • you haven’t processed to a «customer lifetime value» estimate, as you have only non paying users;
  • the discounted Cash Flow calculation give you an estimate of 500k

The mean for your company valuation would be 337k («pre-money» valuation, that is before investment in the company). Now you have a valuation you can discuss with investors! And you also see that the number is completely different from the cash required to incorporate (let say 100k as previously hypothesised).

Let’s assume a business angel commit to invest CHF 50’000.- on a pre-money valuation of CHF 300’000.- (resulting from the negotiations). He’ll own 14.29% (=50/(300+50)) of your company post-funding.

On your registered capital (remember, you’re bringing CHF 50k to incorporate), the effect will be the following:

  • your 85.71% stake in your company is worth CHF 50k nominal capital;
  • the total nominal capital will be: (50/(1-0.1429)) = 58’336.- corrected
  • the amount of shares your business angel gets is 8’336 (let’s assume that a share has a nominal value of 1.-), which represent 14.29% (8’336/58’336) of the company;
  • As your investor paid 50k for 8’336 shares, the value of a share is 6.- (meaning an agio of 5.-/share).

With this example, you see that CHF 1.- of nominal capital is not always CHF 1.- worth!

As a founder, you can also try a trick to bring money for incorporation you don’t have in your pocket. If you have contracted some works with people around you and they really believe in your idea, you can propose them to invest in your company. Again, you could think you have to open the capital of your startup early on. BUT… you can also propose them to transform the bill into a personal loan, with the option to convert it in capital during the first round of funding (with a reasonable discount – you’d like to be fair with people who believe in you). Or that you reimburse at that time.

Let’s assume that one of your friend did some work for you for CHF 7’000.- and he’s OK not being paid directly, transforming this into a convertible loan with a 30% discount. Using the example above (300k pre-money valuation), the valuation for him will be CHF 210k (300k*(1-0.3)) and he will own 3.23% (7/(210+7)) of the company, which is automatically worth CHF 2’677.- more, because the price of the round before the investment of the investor is 300k (3.23%*300).
After the 50k investment of the first business angel, the ownership of the company will be distributed like that:

  • you: 82.95%
  • your friend: 2.76%
  • your business angel: 14.29%

Of course, you’ll own less of the company but the advantage is that you’ve not paid the bill of your friend with your precious and scarce cash. And you can avoid the pain of arguing the valuation of the project with your friend, as it is the result of a negotiation with an investor!