“How much am I worth?” is the question that all entrepreneurs need answered at some point.
The trouble occurs when this perfectly legitimate question consumes the startup team such that all energy is expended in negotiations with investors even before the startup has gotten off the ground. Professional, quality, and smart investors rarely make money at the cost of the entrepreneur. So assuming you have researched the investor(s) you should have some faith in their judgement. At the same time, naiveté should not be the cause of being handed a lemon of a deal. You too should be professional, smart and demonstrate understanding.
Before negotiations, you will need to understand the meanings of 2 terms: Pre-Money Valuation and Post-Money Valuation. These terms will help you figure out what the investor thinks your business is worth (and consequently answer your question). SO what do these terms mean, anyway?
The value of your venture before money is invested is its pre-money valuation. Let’s take an example. Suppose during the negotiations, the investors agree to invest Rs 10 million for 40% of the company. This means that they estimate your venture to be worth Rs 10 million/0.40 or Rs 25 million.
This is the value of your venture consequent to the investment of Rs 10 million. Or in other words, the value of your venture prior to the Rs 10 million investment is Rs 25 million less Rs 10 million or Rs 15 million. The pre-money valuation is therefore Rs 15 million and Rs 25 million is the post-money valuation. Now say that the investors agree to invest Rs 5 million for the same 40%, the pre-money and post-money valuations will respectively be Rs 7.5 million and Rs 12.5 million! Injection of the right amount of capital can therefore double valuations. It is therefore important to be clear about the type of valuation you are seeking from investors.
It is also important to estimate what percentage of the total company will belong to you. To do this, you need to make certain assumptions about the number of shares that will be outstanding at the time your company goes public or is sold (say 3 to 5 years in the future) and then calculate your percentage. Your business plan should tell you approximately how many more shares of stock must be sold (and at what price) before the business is self-sustaining (the financial pro-formas should provide this data).
Remember however that these are just assumptions in your plan; the actual results can be off by an order of magnitude! First, you can compute your dilution factor D: If the total number of shares currently outstanding is O and N is the total number of new or future shares to be sold, then the dilution factor D will be (O/N+O). Your future percentage will therefore be equal to your current percentage times the dilution factor. You can also attach a monetary value to your future percentage ownership (to calculate your fortune!) by multiplying the Market Value of your company by the future percentage! It’s not real yet, but it’s fun!
Here’s an example to illustrate the value of your fortune. Let’s say that you were granted 10% of the company when you launched it and there were 1 million shares issued at this time. Let’s also assume that an additional 4 million new shares were issued later, giving a dilution factor D of 1/5. Then, your future percentage is equal to 0.1 x 1/5 or 0.02 or 2%. Your future worth, assuming your company is worth Rs 2000 million at IPO, will therefore be Rs 2000 million x 2% or Rs 40 million.
It’s highly unlikely that you will be achieving this wealth in a 3 to 5 year time-frame as an employee and, more importantly, having fun while doing it. Which is why you want to start to your own company, right? Easy and fun, huh? Let’s make it happen!
This article was originally published in VentureKatalyst, India’s first e-zine aimed at entrepreneurs, started by Sanjay Anandaram