I figured that there is a great deal of confusion about valuations out there. Hence, I decided to shed some light on this from the other side of the table. I am going to concentrate on early stage businesses here. There is a great deal of books for mature companies (I personally recommend McKinsey’s book on Valuations on this topic).
Misconception #1: it’s all about other valuations
Nothing can be further from the truth. Although this might sound counter-intuitive at first, other valuations are just one piece of the puzzle. Only because a competitor might receive a high valuation does not imply the same for your business. There is a great deal of factors that make up a valuation, even more so in the early stages of a business. The reason why so many VCs state that the team is a great factor, comes from the fact that it is common knowledge that you might switch your business model around three times before you hit the right market.
Misconception #2: the higher the valuation the better
This is something that you might not realize when you’re just thinking about your first round. However, it might get back to you in the following rounds. Down-rounds, i.e. rounds in which the current stock price is considered lower than in previous rounds, may have many implications. For one, your previous investors might receive more shares due to anti-dilution clauses. But even worse: it signals that you might not have hit the target set out by your previous investors, maybe decreasing your chances of raising another round.
Misconception #3: there is a fixed formula
If there were, we would not have those nice negotiations, right? There are many tools that you can use to calculate the pre-/post-money value, the share founders get if the option pool is considered, etc. But the real valuation, determined by the amount of the investment for the share of the company, is always a plug-in number. Therefore, a tool like the Valuation Calculator should not be taken too seriously. There are some indicators (stock market prices, general market development) but they may have different value for different people.
Misconception #4: first revenue means higher valuations
The more data you have on the actual money value of your business, the more likely it is that the valuations from different people might be closer. More data points usually help assessing a business better, hence the valuation can be done more accurately. But it doesn’t necessarily mean that your valuation will rise. If you are greatly underselling your product, this might also indicate that the customer does not value the product as high as you might have expected or your ability to sell is just weak. And having missed certain milestones or not being able to expand the business is at least equally bad for a valuation.
Misconception #5: valuations are a primary business concern
It is reasonable to think that you should only pursue the fields driving most revenue and thus creating most company value. And higher revenues usually drive valuations up. Nevertheless, constant business does not increase valuation. There were a couple of companies which were once valued less than the money they had in the bank. Don’t forget: valuation alone does not help you grow your business–business does.