How much should I raise?
How expensive are your experiments?
In any startup, there are huge risks in your future. Your job as a seed-stage company is to identify the biggest risks and tackle them first.
Money doesn’t buy you a ticket around these risks. Instead, fundraising allows your team to build experiments that attempt to solve these challenges.
At LabDoor, the most expensive part of our early operations were, literally, experiments – analytical chemistry assays that we used to reverse-engineer dietary supplements and energy drinks. In our pre-seed stage, we raised $250,000 from local angels, friends and family. I used my own money as well. That money allowed us to build out our proof of concept – 100 simple LabDoor reports viewable on a web application.
At this point, we had seen 20K+ people use our product, were preparing to launch our first mobile application out of beta, and had clear customer metrics to guide our short-term product roadmap. We just didn’t have the cash or manpower to analyze new products or build applications faster — let alone spare a dollar for a marketing campaign.
The biggest risk for us was proving that consumers would actually use our products to successfully manage their health and safety. Our hypothesis was that if our applications could cover over 80 percent of product sales in the supplement market, and actively engage users at scale to add their products to a ‘LabDoor Cabinet,’ then we could quantitatively prove consumer demand for our product.
We worked backwards from there. I calculated the expected cost of the analytical testing, weighed the value of potential hires, and worked with my team to estimate our annual marketing spend. Then I added the cost of one additional startup experiment in each category (never go all-in on the first shot), and settled at a $750,000 seed round.
How much is my company worth?
Wrong question. Seed-stage valuation has very little to do with the actual liquid value of your company.
It has everything to do with the market value of the convertible note or equity document that you’re selling. Can you demonstrate scarcity in the market, led by respected investors? Who is begging for participation in the round, you or your investors? And what are market conditions in your startup community?
I would suggest finding a valuation that efficiently clears the market for your target raise. If you’re raising $1 million, review recent successful fundraises on sites like AngelList, and honestly assess your startup relative to these companies. Startups with built-in networks (like recent YCombinator graduates) will likely raise at a higher valuation. If you have no clear path to a lead investor, consider dropping valuation below the expected average. Remember, your number one objective here is simply to put money in the bank, so don’t stress too much over 0.5 percent.
If forced to pin down absolute values for 2013 Silicon Valley pre-money prices, I’d label $2 million to $3 million valuations for weak seed rounds, $4 million to $5 million for average seed rounds, $6 million to $7 million for ‘hot’ seed rounds, $8 million to $10 million-plus for all-star seed rounds, $20 million for Jack Dorsey (Twitter edition), and $40 million for Jack Dorsey (Square edition). And expect 50 to 100 percent discounts for any round raised outside the San Francisco Bay Area.
One Final Note
One of the biggest mistakes entrepreneurs ever make is to raise a round of funding at a valuation where they would be comfortable selling the company. At this point, your incentives will be horribly misaligned with your early investors, who are counting on you to bring them a 10x-20x return on their investment.
If you’re trying to make a $5 million to $10 million company, don’t choose investors who are looking for $100 million-plus companies. In many cases, you’ll be better off bootstrapping to profitability with a simple product or service, and building out the company on revenues. (There is absolutely no shame in this – an exit at this range will instantly put you in the top 10 percent of entrepreneurs.)
A version of this post originally appeared on the author’s blog.