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Attracting venture financing, allegedly easier than it had ever been last year, is now supposedly impossible. Especially for Internet companies. But the supposed drought following the deluge does not mean that the smart VC's are turning off the tap for every business plan (just like they weren't funding every plan last year). They still have large funds to spend, and they continue to try to invest larger sums in the really good ones. Choose your sources of financing carefully - your investors are your most important strategic partners, and should contribute a lot more than just money to your business.
My list of links to sources of seed/venture funding is being updated.

How much is your company worth right now? Determining one's valuation is arguably one of the most confusing parts of starting a business. Here's some terminology and some guidelines:
  • Your pre-money valuation is the value of your company just before you get financed.

  • Your post-money valuation is the value of your company immediately after you get financed. Generally,
    post-money valuation = pre-money valuation + amount of money raised.

  • Most of us (and most of Wall Street) don't know how to value publically-traded Internet companies, with real revenues and proven business models. Valuing a nascent business scientifically is even harder. While its hard to get investors to talk about their valuation methods, it appears that most rely on their own 'rules of thumb', rather than on formal valuation models. There are some professional valuation firms like Valuenomics, and they can be helpful, but there's been a big discontinuity point over the last year, so comparables need to be adjusted.

  • Some ballpark figures (these are not scientific -- they are based on word-of-mouth from successful early-stage companies):
    • If your company comprises just you and an idea, you should probably be formulating a solid plan for your business, trying to build a prototype, and/or getting a few people to join/commit to joining once you have seed funding. Sometimes, its useful to raise a few tens of thousands of dollars as well, but your valuation isn't really relevant at this stage. Think hard -- are you really interested in the brutal life of an entrepreneur?
    • If your company comprises a few founders/consultants, a great idea, a solid business plan, a working prototype, but none of you have a proven business track record, your typical pre-money valuation will be in the very low millions ($1 million to $3 million is typical). You should be looking for a seed round of $0.25 to $1 million. This is a difficult environment for you, and you should try getting some experience on your side.
    • If your team has a successful start-up track record, and if you have a 2-5 person management team with significant e-business or technology experience, your pre-money valuation jumps into the high single or low double-digit millions. $6 million to $15 million is the typical valuation range, and you should be looking for a first round of $3 to $10 million.
    • If you also have a rapidly growing customer base, and killer technology, then why are you reading this? There's a dearth of good deals for VC's today -- look for a pre-money valuation well in double-digit millions. And give me a call:)
    Again, these aren't survey or research results -- simply figures I've heard about over the last couple of years. Ask around -- try and talk to any 'friendly VCs' that you know, to other post-seed entrepreneurs, or give me a call. The valuation rules-of-thumb change frequently.
How much to raise
Deciding how much money to raise is driven partly by your cash needs. However, the valuation of your company is also a crucial driver. A 1% stake in hundreds of companies is a lousy investment strategy for most VC's -- they prefer to take a substantial stake in a few good businesses. If your choose a smart source of money, expect to give up a double digit percentage of your company at the seed stage, and about 25% to 40% more when you raise your first large round of funding.

Consequently, sometimes cash needs are calculated backwards. Clearly, more money is better than less. So if you have to give up a fixed percentage of your company anyway, you might as well ask for as much as your valuation lets you. For instance, if you can sustain a pre-money valuation of $10 million, and you expect any decent VC to ask for a third of your company, you should plan your growth with a cash constraint of $5 million or so.

If you've studied finance, this probably seems really strange, and possibly irrational. Perhaps it overstates the backward nature of fund raising. But my information suggests that it is a crucial part of a sensible financing plan.

Smart vs. dumb money
There are still lots of wealthy individuals out there, who know very little about technology and e-business (apart from the fact that it made a lot of people rich, it wiped out others, and there's still a ton of money to be made), and who want to seed technology companies with a few hundred thousand dollars of their savings. There is also an increasing number of savvy angels and seed-round VC's. In general, the latter are vastly preferable to the former. Even if it means a lower valuation.

Most startup-savvy people and VC's of consequence know the distinction between what is somewhat unkindly referred to as smart vs. dumb money. Smart money is funding from recognized angels, business/political leaders, or seed-round VC's. When you raise seed money from them, you get a lot more than just the cash. You get access to their network of potential partners (particularly useful if they are large, non-ecommerce company leads). You get credibility. You get strategic advice, and a valuable board member/advisor or two. You get leads for recruiting. You get access to their friends at larger venture capital firms. Remember, this isn't your last round of venture financing. Hopefully.

Dumb money is simply cash, from a rich, first-time investor. You don't get the other perks. Also, this kind of money is hard to 'service'. If someone doesn't understand venture investing and the world of technology business, they may object to your cash flow plans. They may expect immediate ROI's. They may expect you to listen to their ideas about how to run your business. And they may deter your chances of raising money from the 'blue-chip' VC's. So, even if you get a better valuation from them, think hard. Think long-term. Maximize the eventual value of your company, not your immediate returns. But make sure you stay alive.

Copyright © 1999, 2000 Arun Sundararajan. All rights reserved.