Term Sheet (8) Amount of Investment｜How to determine the valuation of a startup company?

When VCs make investments, there are two main types of investment terms: economic and control, or money and power. Because economic factors are more direct and related to immediate interests, both investors and founders pay close attention to these types of terms. The financing amount and valuation terms, the most important economic terms, are usually the most important to entrepreneurs and the most difficult to negotiate.

An example of a common financing amount in venture capital terms is as follows:

Amount of Financing: An aggregate of SX million, represen-ting a Y% ownership position on a fully diluted basis, including shares reserved for any Prior to the Closing, the Company will reserve shares of its Common Stock so that Z % of its fully diluted capital stock following the issuance of its Series A Preferred is available for future insurances to directors, officers, employees and consultants.

Financing amount:$X million in the aggregate, representing ¥% of the Company's fully diluted shares (including the shares reserved for the employee option pool). Prior to the closing of the financing, the Company will set aside common stock and satisfy the requirement that B % of the shares will be available for future issuance to directors, management, employees and consultants upon the issuance of the Class A Preferred Stock on a fully diluted basis.

Relationship between valuation, financing price

To understand the issue of financing amount, we must first understand the relationship between valuation and financing price.

This is actually a bit like the difference between value and price that we learn in economics. Generally speaking, valuation refers to Fair Market Value, which is the market value that a company should have based on market conditions and actual conditions, so "valuation" is a calculation of the intrinsic value of the company. The valuation given to a company by a VC is actually the "price", which is a subjective recognition of the value of the company by the VC, and the monetary amount the VC is willing to pay for the shares of the company.

Here is the difference between these two concepts:

Fair Market Value (FMV) is calculated based on a fictitious market condition, while price is real.

FMV assumes that both parties have the same knowledge and bargaining power, while the price is influenced by the information and bargaining power of both VCs and entrepreneurs.

Fair market value assumes that both parties are not influenced by external factors, but in reality both VCs and entrepreneurs have certain emotional factors, and entrepreneurs are more affected by financial pressure.

Fair market value assumes that all VCs have the same judgment, and the price reflects the judgment of a particular VC.

Fair market value assumes that there are a large number of VCs in the market who are willing to invest, while in reality there may be very few VCs who are willing to invest.

So that means that because the real world is always an imperfectly efficient market, prices will always deviate from value, especially in the less liquid private equity market, compared to the more liquid public equity market. Despite all the differences between valuation and price, basically all discussions use "valuation" to refer to "price", so entrepreneurs need to remember that founders are talking to VCs about how much shares of the company can be sold for, not how much they are worth.

In fact, how is the valuation of a startup calculated in real life?

How much VCs are willing to invest in you / how many shares VCs are willing to occupy = company valuation

In other words, the reality is that the value is instead the price backwards.

Let's say Guo Jing's Northern Warrior Technology and Yang Kang's Wan Yan AI. These two founders, at that time are the children of the Niu family village (still in the mother's womb child), because to help Qiu Douji and Wang Daoqian in the process of war, their father, Guo Xiaotian died, Yang Tiexin seriously wounded, their mother, one exile in the Mongolian desert, one by the Wan Yan Honglie tricked to do the royal concubine. Fate has so arranged two people to two completely different environments. Guo Jing has an angel investor in Mongolia's Genghis Khan, while Yang Kang has an angel investor in the Golden Kingdom's Wan Yan Honglie. This time the two people get the investment or more evenly matched right.

But Yang Kang's Series A investor is stronger, is then the capital market in the Central Plains in the famous Quanzhen capital. And Guo Jing's Series A investor is much worse, Jiangnan seven monsters don't look in the novel inside a high rate of appearance, but in the investment community that can only be considered a small local funds. This is because Yang Kang than Guo Jing when the strength is very much stronger? No, it is purely a random decision of Qiu Diji and Ke Zhen Evil, one raised Guo Jing, one raised Yang Kang only.

So a company can get how the financing and full of all kinds of chance. If at that time the package is weak did not save the complete Yan Honglie, then Yang Kang's angel investor will not be the complete Yan Honglie, then the route may be changed with it. Similarly, if Li Ping did not escape to the desert by mistake, then Guo Jing's angel investor would not be Genghis Khan.

Considerations on determining the amount of financing

VC would considerations.

Expand the portfolio - less investment. VC to diversify, so each project can not invest too much. If it is like All True Capital, and has invested in Wan Yan AI, and has invested in North Man Technology, then the benefit is that no matter which becomes All True Capital are earning, but All True Capital is indeed the most time and effort spent on the top of these funds in investment, GP Qiu Douji cultivated Yang Kang with 18 years, the back time and again to persuade time and again disappointed. Another GP Ma Yu has seen the problems of the complete AI, but do not want to start a head-on conflict with GP Qiu Dji, so Ma Yu to Guo Jing investment in the beginning to be sneaky, so in fact, diversification is very time-consuming energy.

Investment costs - more investment. VC each investment in a project, need to spend a lot of time and money, if they think a project worth investing, then they will try to invest more, so as to afford the cost of these payments. But it's like West Venom Capital only invested in Metaq, which resulted in the early death of the founder, leading to the loss of all the efforts of GP Ouyang Feng, and even the entire fund had to switch tracks and move to the field of artificial intelligence, investing in the completion of Yan AI.

Considerations for entrepreneurs.

Avoid an existential crisis - more financing. If you've actually spent time in a startup, then you know that one of the questions founders have to discuss every day is how long can our company's money last now, 3 months or 6 months? So if possible, startups hate to raise enough money at once to last 10 years. People may think that it is not necessary? It's true, startups are worried every day about how long they can survive. Let's say that Guo Jing, the founder of North Hero Technology, has met the mountain of life and death robbery dozens of times in his life. Guo Jing when he was a child was almost a spear stabbed to death by Wan Yan Hongxi, thanks to Zhe Bei divine sword to save. Yang Kang in order to seize the position of the beggar's gang leader, in the beggar's gang capital of Junshan Assembly will Guo Jing Huang Rong double bundle, and plug the mouth to prevent them from speaking, if not Guo Jing a flash of light to call the dormant in the body of the power, broke free of the rope, I'm afraid also early by Yang Kang to set up. Then again, Guo Jing in the process of snatching Wu Mu relics, was Ouyang Feng hit a palm, and Yang Kang stabbed a knife, internal and external injuries and heavy, and Huang Rong in the Qu Lingfeng former residence of the secret room for seven days and seven nights to heal from life-threatening. So want to start a successful business, the process is really too dangerous. A little inattentiveness will die without knowing where to die.

Avoid excessive dilution of equity - less financing. If too much one-time financing, because the volume of the company itself is still very small, then the money of investors in the company's overall plate inside the proportion will seem very large, the founder will be too much dilution, which will lead to premature loss of control of the founder. Less money every day worry about the survival crisis, but more money is not necessarily a good thing, such as Hong Qi Gong also once asked Guo Jing in addition to the Dragon Slamming whether he wanted to learn some other kung fu, such as free and easy to swim or something. But Guo Jing at this time is very wise to refuse. Why, for startups, you can use the money at a stage is also limited, but also because of these extra money to give up shares to investors, that is not cost-effective for startups.

Having said so much theoretical knowledge, let's review these concepts again from the most exciting Series C financing of North Man Technology. At that time when Huang Rong roasted chicken, Hong Qi Gong smelled the fragrance and came looking for it, Huang Rong guessed from Hong Qi Gong missing a finger that this is the nine-fingered god beggar GP Hong Qi Gong of North Beggar Capital, and also knew the characteristics of Hong Qi Gong's gluttony. So began to buy with their own culinary skills. From here we can see how full of chance the thing of startup financing, if Hong Qi Gong did not pass by to smell the smell of roast chicken, or if Huang Rong does not know the GP of North Beggar Capital is nine fingers, or Huang Rong will not cook, then the investment can not become. The CFO of the company, who is also the CFO of the company, is also the CFO of the company.

In addition to the Elevator Pitch chicken at the beginning, the next pitch deck is also more and more beautiful, fried centipede, Martyrs soup, and the night of the bright moon on the 24th bridge. This meal a meal let originally only intend to invest in a SAFE northern beggar capital finally decided to invest in a C round, from a move hyper dragon has repentance successively taught to fifteen palms, C round of financing successfully completed. This is actually a consideration when the VC investment, even if the company is very optimistic, you can not invest too much at once. Then what to keep it? The next additional investment. Hong Qi Gong is also the same, and then later Peach Blossom Island North Warrior Technology founder Guo Jing and Meta gram founder Ouyang gram of the time of the match, on the one hand has been after the test of time Hong Qi Gong identified North Warrior Technology next has a great possibility of Huashan Dak listed, in addition to North Warrior Technology at this time encountered foreign enemies need a short period of new capital injection to overcome the difficulties, so at this time only the last three moves also invested into the North Warrior Technology. This place actually has an interesting point, that is, we think about the last three palms in the end is the second tranche of the C round or C-1 round? I think it is C-1 round, because on the one hand Hong Qi Gong in the investment of the first fifteen strokes when there is no next investment in the other three strokes of the plan, and the second tranche should have been planned long ago, but the money in two batches in. On the other hand, because the investment in the last three palms and the first fifteen palms have been separated by a relatively long time, the valuation of the Northern Warrior Technology has also undergone substantial changes, the price per share of the last three palms should be more expensive than the first fifteen palms. So I think that the last three palms of Dragonfall should belong to the C-1 round, rather than the second tranche of the C round.