Funding round values
The following diagrams are a visualization of the value of a growing startup company as it goes through stages of equity funding. This does not show debt financing or valuation decreases.
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At first, the founders begin to develop a product. As time progresses, the intrinsic value of their company increases as they invest their time to improve the product.
When a startup raises a first round of funding, such as a seed round, investors give them cash in exchange for owning a portion of the company’s stock. At the time of the funding event, the pre-money valuation is the value of what the founders created. The post money valuation comprises the intrinsic value that the founders created plus the cash received. The percentage of the post money valuation due to cash is the percentage of the company’s stock that the founders sell to the investors. The portion of company stock sold in exchange for the cash is typically 20% to 35% of the post-money value of the company.
The cash will get spent. The company should sell a large enough share of the company’s stock to take on enough investor cash to get to the next round. However, founders should not take much more cash than they will need to get to the next funding round so that they can keep as large a share of ownership as possible.
With that cash, the company should be able to grow its valuation at a faster rate than it could previously.
The process repeats at the next round, such as a series A financing round. Eventually, the company needs to start earning revenue by selling products to customers. While the investor cash is used up, the revenue brings cash into the company. The more revenue the company can generate, the less the share of the company that the founders and early investors need to sell to the later investors.
When, in the life of a company, the revenue provides enough cash to fund the company operations without any further investor money, the company is profitable. It is in control of its own destiny. Its founders and investors can decide how much, if any, further shares of the company it wants to sell to later investors. Revenue puts a company in a stronger negotiating position with future investors.
Even after the company is profitable, it still might take on further investment money if that will help further accelerate company growth. That can help to stay ahead of competition and capture new market opportunities. Giving up a further share of the company’s stock in exchange for the ability to grow faster is in the interest of the founders and early investors if it enables a sufficient acceleration in the growth of company value.
The amount of a company’s cash can go up and down depending on how much the company spends on growing the number of people in the company. Apple is an example of a company that generates a lot of cash and saves most of it. Amazon is an example of a company that spends most of the cash that it earns from revenue to build the company and find even more sources of faster growing revenue.
Many investors in later stage private companies and public companies estimate the company valuation as a multiple of its revenue. For that, the amount of revenue provides the denominator. The agreed multiple determines the total amount of the agreed value. Different types of companies tend to be valued at different multiples.
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