Roundtable: What Company Valuation Methods Do VCs Use?

Last week, our VC panel discussed the point at which young companies are ready for venture capital funding. In the second of this multipart series, John Greathouse, Andrew Parker, Alex Taussig, Sarah Tavel, and Rob Go share some of the company valuation methods they use when it comes to startup and early stage organizations.

Next week: What do VCs expect to see in a pitch?

What company valuation methods do you use to value a startup?

John Greathouse, General Partner, Rincon Venture Partners

We don’t chase valuations. Thus, if an entrepreneur is looking to maximize the valuation of a particular funding round, Rincon is not the right firm. However, if the startup is interested in maximizing the round that matters most (i.e., their exit), we might be a fit.

With larger valuations, you must accept more capital (and thus more dilution). As such, we put more emphasis on the post money value of a particular round, as opposed to the pre-money valuation. The capital efficient businesses that we partner with can minimize dilution by conscribing the size of their initial funding round, rather than attempting to pump up their valuation.

Rob Go, Co-Founder, NextView Ventures

Early stage companies are valued by a confluence of competition, ownership requirements of the players, and capital needs of the company. I always say that startup valuation is essentially a negotiation exercise – you need to find a ZOPA that the market will bear. Investors can justify valuations based on financial metrics further down the road, such as revenue multiples, GMV multiples, cash flow, and so on. But even those are completely fungible.

There do tend to be trends to valuation based on the type of business you are talking about. E-commerce companies rarely get valued at much more than a couple X revenue. Social services like Tumblr or Turntable.fm get very high valuations if they have perceived traction because investors believe there are “winner-take-all” dynamics in those areas. But the exact number is always a moving target.

Andrew Parker, Principal, Spark Capital

This answer is highly dependent on stage. At Spark, we look at all stages of investment, from seed through pre-IPO.

If the company is pre-launch, it’s largely just a negotiation. If the company is post-launch, but pre-meaningful-revenue, then we try to get a sense of traction relative to the competitive set on both a quantitative and qualitative level. If the company is post-launch and already generating meaningful revenue, then we can look at revenue multiples of comparable companies in M&A transactions or publicly traded (with some scalar to account for the high growth that early stage startups anticipate relative to a mature public company).

Sarah Tavel, Senior Associate, Bessemer Venture Partners

It depends on the stage and type of company. For companies that have generated revenues for several quarters, usually value is a function of a simple financial multiple (e.g., a multiple of annualized revenues). Companies that are growing incredibly quickly will be valued on higher multiples than companies that are growing less quickly.

Valuing pre-revenue companies, on the other hand, is less straightforward. Very early stage companies require a bit of pattern recognition. Companies that have some traction but are still pre-revenue require a scenario analysis. I try to think about different outcomes I can imagine happening to the company (e.g., 30% chance that it shuts down, 20% chance it sells for $100m, etc.), and then calculate a weighted expected return for different valuations. If my expected return is below what I’d like, then the valuation is too high. If it’s above my rule of thumb, then I’ll cross my fingers and hope for the best!

Alex Taussig, Principal, Highland Capital Partners

Early stage company valuations are more art than science. We are constantly in the market evaluating hundreds of startups each month, so we get a good sense of what is reasonable for a particular sector and stage of a business.

Later stage startups are easier to value. We use both trailing and forward multiples based on public comparable companies and recent acquisitions. The most conventional multiples are those based on revenue or EBITDA, although we often use less common benchmarks like gross bookings or enterprise value per active user in some unique cases.

Next week: What do VCs expect to see in a pitch?