The Venture Capital Dream
You may have considered raising money for your startup from a venture capitalist (VC). Not only it’s a great achievement to get your products or services validated but it’s also financially rewarding. A suitable venture capitalist can drastically shorten your market development time and speed up productions, not to mention a successful exit. After all, who doesn’t like another story about a visionary entrepreneur carrying a start-up company from his or her own garage to the New York Stock Exchange? Before you get too excited, let’s take a look and see how much your company is worth to a VC.
How Venture Capitalists Value Your Company
If your start-up is not generating revenue, it is considered a pre-money startup. VC generally uses a scorecard approach to value your company. As the name suggested, the scorecard approach is about the score of your company. And the score is generated by comparing your company with other funded start-up companies. In another words, it’s a market approach.
VC firms pull comparable companies at a similar development stage. If your company is funded by seed capital or angel investing, your company would stand side by side with other companies in the same seed group. The mean value of all comparable companies will be used as a benchmark for your VC capital. Each VC has its scorecard system to generate a weighted-average multiplier for your company. For example, if the VC cares about management and assigns a 50% weight on the experience of the management team and your startup gets a score of 80%. The assigned score for management would be 40% for your startup. The sum of all weighted scores will then be multiply by the benchmark valuation.
Nonetheless, the VC approach is appropriate if your company is generating income or has a solid chance of doing so. The VC approach is a form of income approach and venture capitalists typically value start-up companies based on their required rates of return on the investment and required exit values.