Strong Fundamentals

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Value your business, like you’ve never done before

Matthew Bradley

Investor @ Forward Partners

You want to value your startup. You’ve read the textbook. You have an academic understanding of Discounted Cashflow valuation...but you’re not going to have steady-state cashflows for a decade.

Using multiples seems simple enough...but you’ve not really posted numbers that you can multiply sensibly.

Comparables give you a ballpark but you want to get closer to what your business is worth, not just a similar-ish one. There’s a better way...

  • At the early stage, it’s not really valuation, it’s pricing

  • Work back from what you need to get you to your next milestone

  • Defensible plans = higher valuations

In the public markets, loss-making but ‘hot’ tech companies can command pretty wild valuations. Spotify is priced at roughly a 12-month-forward 17.5x EBIT (i.e. 17.5 times what the market thinks earnings before interest and tax will be in a year’s time). You could make the case that this isn’t an academically rigorous valuation method. However, this is a problem for all high-growth tech companies: how to accurately value the business.

Moving back to the pre-Series A spectrum, it’s fair to say that valuation is more art than science. That’s a problem for founders as the more ‘art’ there is in the process...the more open to interpretation it will be. Practically speaking that means that if the investor has power in the negotiation - which they often do - that investor can interpret the valuation as they wish. In plain English: you’ll get a lower valuation.

Maximising your valuation isn’t something that you should optimise for over and above everything else. Clearly though, getting unnecessarily diluted is something that you want to avoid. So how best to ensure that this doesn’t happen? How do you put more science into the valuation process?

Caveat: what I’m about to recommend is really only applicable for founders going down the VC route and/or raising at least one more round of financing

What you want is to have defensibility for the valuation number that you’ve got in your mind. That’s easy in the public markets because millions of people agree on the valuation methods and the numbers that come out of them. So, what we’re aiming for here then is an agreed upon valuation method.

Step 1: Realise there’s really no such thing as ‘valuation’ at the earliest stages.

Rather investors price your business. Ie// they’ll give you X for Y and your post-money valuation is therefore X ÷ Y, let’s call that Z. Putting some numbers in there, if someone invests £500k and requires 20% equity in return, that means your business is valued at (500k ÷ 20%) = £2.5m. X ÷ Y = Z.

Step 2: Understand convention: a key driver for Y.

Financing rounds follow a pattern. More often than not, financing rounds at the early stages entail raising an amount (X) which will buy a company 18 months runway and will get it to the next milestone that will then entice a new investor to buy in. Similarly, what is being offered in return typically falls around the 20% mark.

There’s a great bit of data from Seedlegals which demonstrates this pretty well (see below). There’s a little hump which I presume represents family and friends rounds whereas the main distribution likely refers to angel and early institutional rounds. The mode in this dataset looks to be roughly 20%.  

Source: Seedlegals


Good news, we now ‘know’ Y. We’re assuming it’s 20% for the time being. That means that we only need to work out X, or how much we’re raising, to get to our valuation.

Step 3: Work out how much money you need to get to the next station on the line.

This sounds simple but we often find this part of the plan isn’t particularly well thought through. It can be a real distraction for founders to take themselves away from the business to properly plan out the next 18 months. But, if you want to have a defensible position in valuation negotiations, this is where it’s at.

Let’s say in 18 months you want to have raised a £5m Series A. That means that you’ll have to be growing fast and likely comfortably beyond a million-pound-run-rate.To pull that off you’ll need sales and marketing assumptions - both in terms of CPAs (variable costs) but also to build headcount (fixed costs) in relation to the business scaling. That also goes for tech, product, operations, administration, rent, etc. The better informed these assumptions are the easier it will be to stand by them.

The best information source is those entrepreneurs who’ve raised that round and ask them how they got from the stage where you are at, to where they are now. Who did they hire, when? How quickly did acquisition costs come down? How did churn evolve? How did your cohorts/customer retention perform? What ‘buffer’ did they have, if any? The more real-world figures you have in your model, the closer the valuation conversion comes to science vs. art.

Once you’ve worked back from what you need to get that big Series A away to the present day, you’ll have a number which is your round size. That number is X.

Step 4:  X ÷ Y = Z.

You know X (your round size). You know Y (roughly what the investor is expecting in return). Now you know Z, your post-money valuation. Are you happy? Is it roughly what you expected? Hopefully, that’s the case. If it isn’t the case you’ll need to head back to varying X or Y.

Y can, of course, differ just like X. Nevertheless, investors’ expectations are powerful. For example, VC funds are looking for the potential to ‘return the fund’ with each investment. Which means that they need to see a massive outcome down the line for you and your business while also getting a big enough stake to return their fund. That’s why a lot of rounds end up at ~20%. If you have a lead and/or institutional investor, maybe a few angels, possibly some people following on you’ll quickly get into that 20% ballpark.

Hopefully, this has helped to look at valuations at the early stage in a slightly different, more scientific light. The better thought out your business plan is and the more real-world assumptions are in there, the more defensible your target valuation will be.



Matthew Bradley

Investor @ Forward Partners

Matthew used to work on trading floors at Lloyds and BarCap before seeing the light. Following an MBA at SDA Bocconi and before joining us he became an entrepreneur and investor in his own right. He’s focused on sourcing and executing deals. His other interests and activities include investment strategy, writing and emoji.

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