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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:
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.