Question: How does one know if an indigenous startup can be valued at $1bn in the next 5 years?
Interestingly enough, only a few startup founders have prerequisite knowledge on how startup valuations work. Hence, the need to give a brief insight as regards how valuations work.
First, valuation is a sort of ‘investment game’ ; It is the result of an exchange of monetary value from the investor into a startup for an agreed share in equity/ownership. It is also the economic process of estimating the value of an owner’s interest in a business using valuation tools.
Valuation in itself is a relatively comparative term. It is used to compare one startup against others or against other related companies, the only yardstick been the amount of external monies or investment it has received. There’s no universally accepted formula for calculating a startup valuation; however, tools like fair market value, investment value and income valuation are usually employed in the valuation of a startup
A mashup of data at Bloomberg by Anna Vital and from Paul Graham’s blog shows that there are, at least, 7 stages of startup valuation from idea to IPO:
- Idea stage
- Co-founder stage (if any)
- FAF (friends and family) stage
- Seed stage
- Series A stage
- Series+ stage
- IPO (initial public offering) stage
So how exactly does this work?
Technically speaking, at the conception stage of your startup, it is valued at 100% of nothing. Assuming you decide to reach out to another person who keys into your startup idea and you mutually agree that said person(s) contributes a skill-set previously lacked by your startup, this also amounts to 100% of nothing. What you now have are 2 shareholders owning 50% each of nothing as the idea is yet to become a working minimum viable product, MVP.
As you begin to draw closer to MVP, the need to assemble a team is inevitable while holding on to bootstrapping. Co-founders may then see the need to set aside 20% of said startup for team members (present and future) as an incentive for working with you while awaiting income generation from the business.
You may have also convinced Auntie K to commit N200,000 to keep your dream alive but Auntie K only agreed after you offered 5% of your startup in exchange. Bear in mind your startup total valuation is still 100% of nothing. The breakdown now stands at 37.5% each for the co-founders, 20% for early and future employees, and 5% for Auntie K. This N200k from Auntie K is a very important milestone for your startup as it prepares you for the Seed rounds of formal investment.
With a struggling team now in place, you successfully arrive at your MVP and launch your startup; Your startup begins to gain traction with some users and some growth numbers for investors to crunch, you have received your first formal (seed) funding of N2m from Mr.Smart which now gives your startup a valuation of N10m assuming you agree to release 16% of your startup to him.
Your startup pie is now 31% each for the co-founders, 16% for early and future employees, 4% for Auntie K and 16% for Mr.Smart.
Remember, there is no formula for determining this magic ‘valuation’ numbers. It is usually worked out between co-founders and their lawyers with expertise in investment banking and Mr.Smart (and his associates); However, it must include wide consultations with professional investment analysts, with extensive consideration relative to already valued startups and a chunk of numbers to crunch (at Bloomberg).
Having secured seed funding, the next valuation stage is Series A – usually involving a significant increase in funding compared to the seed rounds. Assuming your startup received N20m from Sky Partners (a venture capitalist), this will give your startup a valuation of N40m assuming you agree to part with 30% of your company to Sky Partners (comparative numbers here). This shrinks the cofounder’s share of the pie to about 19%, 13% for early and future employees, 2.5% for Auntie K, and 10% for Mr. Smart. Other series of funding may follow, a development that will prepare your startup to become a company that is publicly traded in the stock market (IPO), where it may be reach valuation of hundreds of millions (perhaps billions) of naira.
Till next time!
Author: ChuQDennis
Image credit: dmgoffices.com
