Jimmy Arcillo from Underscore breaks down seed valuations, which rely more on market demand than formulas. Seed investors typically want 10-20% ownership, and setting your valuation too high creates overhang that hurts future rounds. Match your ask to what you need and what you can accomplish before the next raise.
Chapters
Foreign. I'm Jimmy Arcillo, I'm an operating partner at Underscore and I'm going to be sharing with you some insights around how valuations work. At seed, we get a lot of questions about valuations and I think it's important to understand the stage of the company you're at. So if you think about the difference between art and science, later stage evaluations, generally, you know, they're more math driven, multiples driven. You can use a lot of fundamental valuation techniques that you would even in public companies because you've got real cash flows. And the earlier stage, it's a little bit more of an art. And so the dynamics at play are supply and demand. So in markets that are really cranking and you've got a lot of activity in a market, many term sheets valuations are driven by the demand for your company, the demand from investors, how many folks you can bring around the table. So one of the best things that you can do to drive up your valuation would be to have several offers from other investors. So if you've got a company that's operating in a really big market and you've got a team with a qualified opinion on how this market's going to unfold and a solution to a significant market pain point, you're going to have a higher valuation. There are also other intangibles that go into this. The best founders really create a sense of fomo. You get a sense that the founder understands the market in a way that others don't, that they can drive a product that will solve that pain point in ways that others don't. And really that they can build a team that sort of wraps all of these concepts together to drive valuation. I think that seed stage valuations are generally insulated from what's going on in the broader economy, because the time horizon from for taking a company from seed to later stage is generally, let's say, 10 plus years. And so C stage valuations generally follow a set of rules and a tight band in terms of what the number is. One of the first checks that I make is I talk to our attorneys, they see a lot of deals and so I ask them generally what they're seeing in the market. Lawyers, your counsel, have a good lens on what's happening in the market. I look at things like PitchBook, CrunchBase, we look at Omni, which is a tool that J.P. morgan has that shows how rounds have changed over time and generally the size of rounds in terms of what valuation you pick for your company. I think it really does Depend. You don't want to take too much capital. You don't want to be in a place where you are not capital efficient. You also don't want to take a valuation that's too high that you're going to have to grow into over time. So a lot of founders have the misconception that they want to go with the highest valuation they can achieve or they can get from an investor. That's very often a trap. One of the things you should realize is that markets fluctuate and as you grow, market multiples, or what folks are willing to pay fluctuate over time. So in a great market, let's say that you could get 20 times revenue and you've got $5 million of ARR. That implies that your company, all other things equal, is worth $100 million. But markets can quickly change and contract and multiples may go down to 10 times revenue. And so your $100 million company from two months ago is now worth $50 million. And that creates a problem for you because that's a valuation overhang. So the next investor that comes in is going to say, you know, your company was valued at $100 million. We believe it's only worth, let's say, $75 million now. And that creates a disconnect between your incoming investor set, your current investor set, and the value that the market's going to perceive you've created over time. And so it isn't always the best idea to go with the highest valuation. The best idea is to go with the valuation that is appropriately market based and brings in the amount of capital you need to hit your next inflection point or milestone. One of the things that's very important for founders to understand is how venture capital works. So generally, seed stage investors want to have between 10 and 20% ownership, knowing that further dilution is coming down the line at the A, at the B, at the C, et cetera. So let's say that an investor wants 10% ownership and you need $5 million of capital. That would be a very high seed stage valuation at $50 million. And that's important to think about. Matching your capital needs, how much capital you're trying to raise with your seed stage investors. Ownership target. One of the biggest things that you can do to set up your relationship with your new investor on the right foot is really work with them to understand the journey you're trying to go through, how much capital you need, what your milestones are, and then making valuation a function of that and, and thinking through the overall journey on a holistic basis. The best founders have a plan and they understand where we fit into that plan. It's really important to us because what we want to do is be able to help and support you along the way and know that our help and support matters to you.
