Analyzing Valuation Of Pre-Revenue Subscription Startups – How Much Equity Should You Give Out?
Oh, and there's a Google sheets template that I constructed a few days ago.
🕒 Here‘s a TLDR summary:
💵 Many clients often ask me, “How much equity should I give that investor?”
📊 You need the money to start or grow, but the answer to this question is quite chaotic. It could be that what you’re thinking is too low. But it could also be that the investor is getting a bad deal.
⚂ Three quick rules to remember when constructing such a financial model. I’m focusing here on pre-revenue subscription models.
It’s never too much or too little.
There’s always a company to watch.
It’s a gamble; the investor knows it.
📟 (Free For Paid Subscribers) I constructed a Google Sheets template of a minimalist financial model for a subscription business with a valuation that simply answers the question above. The final valuation page has something that looks like this (It’s a slow GIF, be patient with it):
How much equity should you give out?
Let’s make one thing clear: If you are a pre-traction startup, then this question has no correct answer.
A founder’s worst mistake could be selling 10% of their company.
Another’s best decision could be selling 70% of their company.
When you don’t have traction, you don’t have tangible data that makes you answer this question correctly.
But let’s say you’re answering a multiple-choice question, and you don’t know the right answer; what do you do?
You can guess; that’s sad. But you could.
You can eliminate some wrong answers.
Put yourself and the investor under the proper “investment amount umbrella.”
How do you eliminate the wrong answers? By doing a lot of research.
3 Rules To Remember Before Pitching A Number
You’ll need to construct a financial model or an income statement. But before you do that, you need to know every single thing about similar companies.
Rule#1 - It’s never too much or too little.
You have to keep this notion in mind. There’s no correct answer. You might be satisfied with giving out 20% of your company even though it’s above average.
You might believe that the investor is bringing more things to the table that make it worth it.
Rule#2 - There’s always a company to watch.
Even if your product is out of this world, there are always companies to watch. There are startups who have a similar market or product that you can learn from monitoring their data:
You won’t be able to obtain all this data, of course. But you’ll be able to get some of it. This will be your first stage.
Rule#3 - It’s a gamble; the investor knows it.
Investing in an early-stage startup is not the same as investing in the stock market. Investors know that quite well. It’s one of those high-risk, high-reward situations.
For instance, Union Square Ventures invested around $5 million in Coinbase before Bitcoin became popular. Fast forward a few years, and this $5 million turned into $4.6 billion.
Others like Softbank lost $6.2 billion in investing in WeWork.
Financial Model (Pre-Traction Subscription Model)
So, assemble as much data as you can in your financial model. I’ve built one recently that helps pre-traction companies predict this valuation and the answer to the question.
The process is not that difficult. You simply have to research the following:
What’s our year one user count target?
What percentage will convert to paying users?
What percentage will convert to corporate users?
How much will you charge users? Corporates?
How many of your customers will keep using your platform?
By what rate should your users grow per month?
Amongst other questions, your answer will be more or less close to reality. However, always keep in mind that when you launch, the numbers could vary differently.
The template that I worked on has a dashboard that looks like this:
But the most interesting part is in the valuation sheet:
If you’d like to access it, you can do so from here (if you’re a premium user, you can get it for free by using the coupon code at the bottom of this article.)
Remember, it’s just a conversation; Focus on the bigger picture, and you’re good to go!
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