FounderX 2022: Making Sense of Startup Valuations, Q&A Session with Kamal Hassan (Loyal VC)

Let me be the first to welcome everyone back, and this session is on startup valuations. It's called Making Sense of Startup Valuations. Kamal is going to give a very quick presentation, about 20 minutes long, and then we'll do some audience Q&A. So let me be— let me introduce Kamal. So Kamal has been a very long time local leader of Founder Institute. He and I first started working together with Founder Institute, Rana. He eventually moved over and became a venture capitalist at Loyal VC. And he's been working with Founder Institute companies all over the world as one of the number one funders of FI alumni. So Kamal, do you want to do a really quick introduction on your side? And then we'll jump into your presentation?

Sure, perfect. Well, I think you did a great job there. I mean, founding partner of Loyal VC. We We've funded 125 Founder Institute companies over the past 4 years since we launched. It's actually one of 2 themes of our fund. We do Founder Institute and NCF Business School. So I always love working with Founder Institute companies. If you're ever interested in hearing more about funding with, with Loyal VC, if you're a company, talk to your director, have your director contact us. We try to sort of get a feed out and get background on people through the local directors.

Awesome. Yeah, it's been great working with you, and it's been really cool to see your fund grow. And thank you for all the support that you've given Founder Institute alumni. So why don't we jump into your presentation today, and then founders, uh, and investors who are in the audience, go ahead and put your questions in the chat and we'll get to them afterwards.

Perfect. Let me just sort of pull up a little screen here. Uh, it should be good, one hopes. So I'll probably, given the timing, I'll probably make this a little bit faster, probably closer to 10, 12 minutes, and then we can jump straight into questions and we can cover everything there. But this is a little talk about venture capital valuations, how to make sense of valuations, and one way of thinking of it is exactly wrong or approximately right. But you've already heard a bit about me. What's probably important is our fund is an open-ended venture fund. So we actually do a full valuation of 250 companies 4 times a year. So yeah, I've got a lot of experience right now at valuations and had a chance to really think an awful lot about what's involved in valuations. My background, by the way, been an entrepreneur, been an angel investor, a company, and Seattle MBA. So the question every entrepreneur always has is, what is your company worth? And I have a very simple yet profound answer, which is your company is worth what people will pay for it. So if people for $500 get 0.01% of your company, your company's worth $5 million. If they get 0.005, it's $10 million, or it's $2 million. But it's really simple. They give you cash, you give them a certain fraction of your company back again. That is what your company is worth. Now, does that sort of sound like you could make up whatever price you want? Well, you know, you actually sort of can as an entrepreneur. The thing is, Economics 101, there are these things called demand curves which says the higher the price which you put on your, on your company, the fewer people are going to want to buy it. And many entrepreneurs don't think about this. You can set your valuation at $2 million, at $5 million, at $10 million. All you're doing is you're limiting the number of people who will be willing to pay that price. Hence, you are limiting the number of potential investors you have. But this is also really worth understanding is this concept of demand curves. Now, there are some rules of thumb that people use when valuing your business. And if you think about the sort of the stages companies go through, you have an initial period before you have revenue when your company is really being valued based on vision, based on excitement, based on the investors really just wanting part of your business. But there's really no revenue metrics to do that with. And it depends where you are, but as a general rule globally, it's hard to fear a company be worth less than $1 million because under $1 million, it's not worth your while to do it, and you might as well just get a job. And $5 million is about the level at which, you know, anything less than $5 million, it's a vision valuation. Nobody cares about revenue. Once you sort of cross this $5 million range, people start looking very seriously at revenue, and there's often revenue metrics which are used for valuation.

And people, it looks like we might have lost connection with, uh, with Kamal. For the founders that are here, I'm actually going to share something with you really quickly. Kamal and I, um, even, even despite the technical difficulties that we're experiencing, uh, we had a good talk around valuations and around like how VCs look at the value of your company and how founders should think about those, those valuations. Um, and so while we wait here, I'm going to go ahead and share my screen Some of you who, who have seen this already, maybe you've joined Founder Institute's Funding Lab program or you've been a part of one of our, uh, other equity and funding sessions. There's something that we use that helps sort of give benchmarks for the milestones of funding that you have. So if you can go ahead— does everyone see this? Just give me a quick thumbs up. This is what we look at, um, and again, there are no hard and fast rules here. These are just things you should keep in mind as you're going to raise And so, you know, as a fund manager, here's sort of how I would look at this. You know, if you're a pre-seed company, right, your round size is between somewhere between 0 to 750K valuation, you know, 1 to 5 million, which is what Kamal was saying, right? This is largely like, you know, getting a little bit of validation with your customers. And so in order to raise capital, or one of the benchmarks at that pre-seed phase is over here on the right-hand side. Where if you're a SaaS company, maybe you have some paid pilots, some initial revenue coming in. If you're deep tech, it's super important to have that strong leadership. And then if you're doing marketplaces, you need to have a little bit of revenue there. And then as you get, you know, a little bit further up the chain, if you're raising like up to $4 million— so in this column here, you might see the seed column— if you're raising up to $4 million, you might expect a larger valuation of, you know, 4 to 10 Depending on where you are, you could even see this valuation a little bit higher than that if you're on the, you know, later stage of this $4 million, uh, spectrum. Uh, but this is the traction that you would need to justify that. So if you're doing SaaS and you don't have $20,000 a month in recurring revenue, you know, which is sort of the, the low end, is the minimum here, you're gonna have a much harder time raising capital compared to someone, some other company that does have that, um, that valuation. and that, that traction. And so we use this as a way to just kind of measure and give founders a way to, to, you know, benchmark their own progress and success. And so when I'm looking at a company to invest in, I look at how much money are they raising, what's their current traction, and then what will their traction be when that money is spent. Because I know if they're raising $750K in this pre-seed round, and if that can get them to let's just call it $50,000 a month in recurring revenue, then they're much more likely to be able to raise that seed round or Series A as they kind of go up and further along with that, that traction. And so I share this with you. I'm happy to send this out. We also talk about this in Funding Lab to kind of discuss the different benchmarks for valuation. And so, Kamal, I'll hand it back over to you. Um, we, we couldn't see your screen before. You just shared it and we were able to see it. So I don't know if you want to continue with your presentation, but we can also do Q&A. I see if there are some hands here.

Let's just move to Q&A. Happy to take the questions.

Okay, let's go next. So, uh, let's bring Tasheen up here and then we'll go to Cindy. Tasheen, can you hear us okay?

Yeah, I can hear you just fine, Ryan, and, uh, Kamal too.

Great.

So I was wondering, I was wondering In a pretty crowded market, if you're working on a, basically on a market disruption model, what sort of valuation method should you use?

It comes back to the rules of thumb I mentioned, which is, do you have revenues or don't you? If you have revenues, you're being valued as a multiple of revenues. If you don't have revenues, it's an idea-stage company, you need to find people who like the idea, you're valued somewhere between $1 and $5 million.

Okay, okay, I understand. And if I do have revenue and enough traction and I have, uh, a significant amount of market penetration, let's say within the first 6 months of launching, what then?

Well, people are just going to value it 5 to 10 times your revenues. Whatever your revenues are, take your monthly revenues, multiply by 12, multiply by 5 or 10, that's your valuation.

Thank you, guys.

Yeah, a lot of that too, just to kind of put a point on it, is, is you can say what your valuation is, right? You could do like 5 to 10x your revenue, and that puts you in the ballpark of being reasonable, uh, and like there's like a defensible argument. But at the end of the day, like, the person's gonna negotiate with you and tell you what they think the valuation is. And at least that will give you a framework to know that, you know, you're getting a good deal. Uh, the next question here is from Cindy. Cindy, I'm going to go ahead and hand you the mic. Hey Cindy, how are you?

I'm doing great, thank you. Um, so I wanted to find— ask a question about how you tackle bias. So there was a study done, um, where in the Bay Area, New York, Boston, Los Angeles, and Seattle, where the difference in male-founded companies and female-founded companies, the valuation was about 178% difference. Despite female-founded companies generating about a 35% higher return on investment than their male counterparts. So what is— just because valuations at the earliest stages are a lot more art than science, so how do you accommodate bias in that art side of the valuation?

There's sort of two sides to it. One side is that, look, if you're doing a multiple of revenues and you're using the same multiple revenues no matter who it is, then you're going to end up with a very unbiased approach. However, the second part is to Ryan's point is that this is a negotiation. And to the extent that you've got male founders who are saying, hey, my company is worth a much higher multiple or a much higher number, and the female founders aren't negotiating the same way, then you may see a bias showing up there. And that bias is not— is just sort of a straight negotiation. The people will take the best price they can get. So yeah, so as a woman, do your negotiations, try and negotiate for a better price. But also, if you want to remove the bias, just use straight numbers. Here's a multiple revenue, done.

Yeah, I love that suggestion, Kamal. I mean, one of the things I definitely recommend, just point to data and back it up, right? You know, it's, it's You know, if you're looking at the art side of it on the negotiation side, you know, there's, there's, um, you know, a lot of different ways that you could, you could kind of improve negotiating skills. But if you actually point to data, use numbers to defend it, then it's, it's much harder to be biased against data.

Can't argue with numbers. But I guess the other point is that if you're using, um, so 92%, 96% of historical valuation data, is based on, well, is biased, right? Because it's based on male white-founded companies. So how do you, how do you account for the historical data that's being used? Because they're numbers as well, right?

Well, I, I think there's historical data and then there's like current market data, right? So like you're actually, what you're doing, what the investor's doing is trying to think of like, what's the return gonna be in the future? So there are absolutely historical benchmarks, right? But like you can look at even in like the public markets, like you've seen multiple revenues of public companies. Like you could look up what their valuation, their revenue multiple is. And so a lot of VCs will, especially like, you know, the kind of like mid-stage VCs will use those public multiples as a way to figure out the valuations. So it's less about like historical bias as it is like what's happening in the market and what are the current multiples that are there. And that's where you can actually use that to your advantage. Right now, you could argue that like, you know, the current multiples are biased, right? But that's the market that we're in and it's gonna be hard to fight that until more women like you start companies, become, you know, join the other side of the table, invest in more women's startups. And so it's, you know, it's really a market condition.

Thank you. And yes, I've developed a company that actually tackles that bias for valuation.

So Oh, that's nice.

Yeah, very cool. I see, uh, Samir has raised his hand and then Tarun also, so I'm gonna go to Samir and then we'll do Tarun after. Samir, how are you?

I'm good, thank you. Hi Kamal, good to see you. And another Founder X, I think you met 5 years ago, uh, in Silicon Valley. So good to see you again. The question I have is about, uh, the arbitrage opportunity that might, uh, exist in um, in the valuation terms that, you know, you set up the business in a low-cost country like Africa or India— I know you're laughing— or, you know, relatively speaking, and you have money coming from countries like US. What do you think of that? I know that you've recently invested, uh, you know, and, and for— I, I won't, I won't go in the depth of that The Singapore, you know, the guy who was setting up food transport from one country to another.

And sure.

Yeah.

Yeah. You're talking to a global VC. We see this all the time. Yeah. So how do you see that? Well, so as far as an investor is concerned, I think it's brilliant arbitrage. I mean, you can take the exact same company and if you start it in, call it in London, in the UK, your value will be 1x. If you move that same company to Silicon Valley, you double it in value. And if you move that same company to Mumbai, it halves in value. And that's just the reality of that's what the markets look like. We arbitrage that all the time. We've made some amazing investments in Nigeria and India and in places like this. And we've turned down follow-on investments in Silicon Valley because the multiples, where you just sort of say, well, hey, I can buy— $5 million will buy me a company with sort of a million dollars of annual sales in India, and it'll buy me $100,000 in annual sales in Silicon Valley. Where do I want to put the money? So it's— so yeah, we do that all the time. I think it's an amazing arbitrage opportunity, but it comes back to the supply and demand. I talked in the beginning about demand curves. And the thing is, there's a lot of supply of capital in Silicon Valley because there have been a lot of successful entrepreneurs, and successful entrepreneurs like to invest in other startups. And that just makes that a very unusual market where there's just a ton of cash chasing, chasing few deals.

Yeah. Now it sort of begs another question, you know, what are your sweet spots in hunting for such arbitrage opportunities in different parts of the globe? Would you kind of say that, you know, in certain countries, a certain economy?

No, we just invest everywhere. We invest everywhere, makes it easy. And then you compare it. We like to compare companies on a one-by-one basis rather than trying to do a global basis.

Yeah, okay, sounds good. Thank you, Kamar. Thank you, Ryan.

Thanks.

All right, I'm going to pass the mic over to Tarun. And again, if you have questions, go ahead and raise your hand, call on you. All right, Tarun, can you hear us okay?

I believe this is Martin.

Ah, hi, there we go.

Hey, hi Ryan, hi Kamil.

Thanks for joining us. Uh, what's your question for today?

Okay, so, uh, while funding and valuation, as we know, they are talked about, uh, a little more in the media, and hence get a little more glorified. But because of which many entrepreneurs start to believe that funding and valuation is the purpose of life. And no VC wants that. Because I talked to entrepreneurs, I also speak to VCs. They actually want founders who are rooted in purpose. But that does not get talked about a lot. So my question is, Kamal, and that this is what I'm asking you— we're also speaking on chat separately, you and I— would you place a premium on a company where you can see clearly that they have a well-thought-through strategy on values, vision, and culture? Because in my opinion, that would have significantly higher odds of success, given everything else is the same.

So VCs look at different factors, and it depends very much on the VC you're looking for— looking at. My, my personal view is that vision, values, purpose will show up in the bottom line. So I'm going to look at the bottom line with the assumption that well-run companies will have good results which come out of it. Other VCs may very well look at that as a primary factor. And every VC is individual. They've all got their own biases. And my bias tends to be more of a bias on show me, and what you show me, I'll believe. And other VCs will like vision. They'll like to hear a pitch. They'll like to hear purpose.

Yeah, but what about the early stage guys? Because at that—

doesn't matter. You can still show me even at the early stage. You can show me what you've done. You can show me people using your product. You can show me, uh, development sort of step by step. You can show me mailing lists, you can show me all sorts of stuff to show progress.

Yeah, sure. And I'm saying if you have two companies that have similar histories in terms of growth path, market, audience, etc., but one of them has a clear, distinctly thought-through, uh, strategy around why they are driven in, rooted in values, vision, and culture, whereas the other one is just chasing the market So then the honest truth I'll give you is I'll say, I'll talk to a guy like Ryan and say, hey Ryan, you know both of these companies, you've been working with them for 4 months, which one would you recommend is more interesting?

Honestly, because Ryan knows them far better than I do. So I would, I would then ask him that question, say, help pick these companies for me, help identify. Because that's the thing, as a VC, I don't have the time to really get to know businesses in detail unless, I mean, our process is we do small checks, we get to know the companies in detail. So I'll find out a lot about you after we've invested, but before we've invested. I don't have the time to check all these things. And some people screen for it, some people don't.

And, and, you know, if you were to ask me that, Kamal, I would definitely say that the person that has the, the stronger vision and values, like, that I would argue that they would get a premium. Now, it wouldn't be enough of a premium to be like significant. It would be like, you know, within reason. But I do think like that's extremely important. It really is like the founder, the person behind it that's going to drive it to success. Um, and so I really, I would, I would advise you on, on the one with, with, you know, the stronger vision values. I do