This must be the #1 question when talking with founders about venture deals.
The answer is actually not that hard to figure out if you use the following logic.
When will you (fictively) sell your startup? Assume at the end of year 3.
What are your startup’s earnings before interest, tax, depreciation and amortization (EBITDA) in the year after exit? Assume $1.0m.
What multiple is a buyer willing to pay for your startup at the time of exit? Assume 5.
An EBITDA of $1.0m and an EBITDA multiple of 5 result in an exit value of $5.0m.
How many milestones do you have to achieve before your exit? Assume 3 milestones.
What is the probability of success for each milestone? Assume 80%.
Three milestones with a probability of success per milestone of 80% result in a probability of success for your startup of 51%.
An exit value of $5.0m and a probability of success of 51% result in an expected value of $2.6m.
What internal rate of return (IRR) does an investor want? Assume 10%.
An exit in 3 years, an expected value $2.6m and an IRR 10% result in a valuation for your startup of $1.9m.
Scope: 1) you are at seed stage, 2) you raise 1 round of financing and 3) you are debt free at the time of exit.
Revised on October 14, 2016 for better readability.
Thanks to Hans Westerhof, Chretien Herben, Sander Ten Kate en Derek De Rie.
Venture Value does startup valuations for founders who want to raise money with an investor.