Your valuation is driven by your exit value and your money multiple.
You can use the following logic to calculate your money multiple if you plan to raise 1 round:
What internal rate of return (IRR) does the investor want to make on his portfolio? You can look this up at investeurope.eu. Assume a 15.0% IRR.
When will the investor sell his shares? Assume that he exits after 5 years.
A 15.0% IRR on his portfolio and 5 years till exit means the investor wants to make a 2.0x money multiple (MM) on his portfolio.
How many milestones do you have to achieve until the time of exit? Assume 5 milestones.
What is the probability of success (POS) for each milestone? You either achieve a milestone or not. So assume a 50% probability of success per milestone.
Five milestones with a 50% probability of success per milestone results in a 3.1% probability of success for your startup.
A 2.0x money multiple on the investor’s portfolio and a 3.1% probability of success for your startup means the investor wants to make a 64.4x money multiple on your startup.
Wait, what? 64.4x? I have to discount my exit value with 64.4x? Really?
If you raise a Series Seed: yes, really.
A seed-stage startup typically has at least 5 years and 5 milestones to go before an exit.
A 15.0% internal rate of return and 50% probability of success per milestone aren’t too weird either.
And that’s when you raise only 1 round. If you plan to raise more rounds, your Series Seed money multiple will be even higher. More on that in a later post.
But what about all those angel deals at a $1-2m valuation?
Angels generally overvalue startups.
They would need an exit value of 64.4 * $1-2m = $64-129m to make a 15.0% internal rate of return.
With a 5.0 EBITDA multiple you can only get a $64-129m exit value when the startup makes $13-26m EBITDA in year 5. I can think of quite a few recent seed and crowdfunding deals where that doesn’t seem very likely.
And again, that’s when the startup raises only 1 round. More rounds = higher Series Seed money multiple = higher required EBITDA in year 5.
Thanks to Hans Westerhof and Chretien Herben.
Venture Value does startup valuations for founders who want to raise money with an investor.