Let’s start by discarding two myths:

- Investors do not want control of your company! That is the last thing they want. What they do want are (a) handsome returns, and (b) for
*you*to responsibly manage your own company so they don’t have headaches. - Investors do not care what past valuations were. On previous rounds, you may have received poor advice and valued your company at, say, $5M, and you found some unfortunate investors to purchase stock at that ridiculous valuation. Oh well, that’s too bad. It has zero effect on what the company is worth today.

## What do investors want?

So, what do investors want? And how will they decide what your company is worth? Five main factors influence them:

- Is the opportunity exciting? If it isn’t exciting, they won’t bother valuing the company at all.
- Is the team qualified to execute on the plan? If not, you just aren’t worth the risk.
- Valuation based on current performance. Based on current trailing financials (i.e., what you have already done regarding revenues and profits), and multiples applicable to your specific industry, what is your company worth today?
- Valuation at desired time of liquidity. Based on expected performance (i.e., what you say about expected revenues and profits in your plan), and multiples applicable to your specific industry, what will your company be worth in the future? See below and blog on Determining Future Valuation.
- At what stage is the company? The biggest hurdles a startup has are:
- building a product
- getting the first revenue
- demonstrating a repeatable sales model
- demonstrating sustainable growth without continuing to invest external cash.

As you jump each of these hurdles successfully, the risk of total failure decreases significantly. Investors have their own rules of thumb about how that “risk of total failure” affects valuation. Here are my rules of thumb:

- If you have not yet built your product, assume valuations will be no more than 25% of the valuations calculated using the techniques shown below.
- If you have built your product but have not yet received revenue, assume valuations will be no more than 50% of the valuations calculated using the techniques shown below.
- If you have built your product, started receiving revenue, but have not yet demonstrated a repeatable sales model, assume valuations will be no more than 75% of the valuations calculated using the techniques shown below.
- If you have demonstrated a repeatable sales model and are looking for investments to “ramp up,” then the following techniques for valuation are applicable.

## What To Do With Future Valuation?

Let’s talk a bit more about item 4 above. What will investors do with that future valuation once it is computed? They certainly won’t use it for today’s valuation. What they will do is use it to determine what value the company needs to have today so they can receive an acceptable return on their investment. Assuming that FV is the computed future valuation of the company at the time of liquidity, IRR is the investor’s desired rate of return and n is the number of years between now and the liquidity event, the calculation goes as follows:

Current Value of Company = FV / (1 + IRR)^{n}

So, for example, let’s say the FV is determined to be $15M (using the techniques of the blog, Determining Future Valuation), and the investors desire a 50% IRR (not unreasonable considering the degree of risk) over 5 years. Plugging those numbers into the above formula, we get:

Current Value of Company = 15M / (1 + .5)^{5 }= $1.98M

So, if you are looking for those investors to invest $500K now, expect them to ask for 25% of the company (because $500K is 25% of $1.98M); if you are looking for those investors to invest $250K now, expect them to ask for 12.5% of the company. And so on. But this applies only after you have demonstrated a repeatable sales model.

Now you need to factor in the risks described above. If your company is:

- Pre-product, valuations decrease by around 75%. So continuing with the above example, the company now has a current valuation of around $500K. So, if you are looking for those investors to invest $500K now, expect them to ask for 100% of the company (obviously not a good idea); if you are looking for those investors to invest $250K now, expect them to ask for 50% of the company.
- Pre-revenue, valuations decrease by around 50%. Continuing with the above example, the company now has a current valuation of around $1M. So, if you are looking for those investors to invest $500K now, expect them to ask for 50% of the company; if you are looking for those investors to invest $250K now, expect them to ask for 25% of the company. And so on.
- Pre-repeatable sales, valuations decrease by around 25%. Continuing with the above example, the company now has a current valuation of around $1.5M. So, if you are looking for those investors to invest $500K now, expect them to ask for 33% of the company; if you are looking for those investors to invest $250K now, expect them to ask for 16.6% of the company. And so on.

None of the above is motivated by greed or a desire for control; it is pure economics. Investors want (and deserve) a fair return for their investment.

Of course many other factors come into play including experience, negotiation skills, degree of desperation to obtain cash, and availability of competition for deals (for the investor) and investors (for the entrepreneur).

Davis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and the author of six books.