Despite the glorified status that entrepreneurship has obtained in modern culture, it’s a huge pain in the pass. The work is long. The lows are low. Showering? Good luck with that.
One of the worst parts about being an early-stage founder, however, is realizing just how little you really know about the broader ecosystem that you’re supposed to navigate your way through — and not having time to figure it out. There’s no shortage of venture capitalists posting tips about crucial decisions you should be making, but who has time to read all of it? Again, you are a person who has to be strategic about basic daily hygiene because you’re so damn busy.
Well, good news. As often as we can over here at TC, we’re going to take on one of your questions and bring you the feedback of numerous experts. (This may become a weekly thing; we have to see how it goes.)
Let’s kick things off with our very first question from a reader, which is: “How do you establish a valuation for a nascent SaaS startup when there are no similar products?”
While we find it difficult to imagine a nascent SaaS startup with no similar products (c’est possible?), plenty of the pros in our network have some great advice on this very topic.
First, you can focus on underlying business metrics to get to a valuation, suggests serial entrepreneur Peter Kazanjy, who says “product variety” matters a lot less than these numbers. “A SaaS company exists to solve business problems and provide customer ROI and in return gets recurring revenue at fairly high margins — at least if it’s typical SaaS. So its value is contingent on how well it achieves that goal.” What metrics are most important? Think monthly recurring revenue, monthly bookings, customer lifetime value (though this one is “pretty tough to converge on very early as your initial churn numbers are likely not very accurate,” Kazanjy notes), customer acquisition cost ratio, churn, and your startup’s growth rates.
What? Your company is too young to look at said metrics? Okay, fine. Let’s say that it’s pre-revenue. In that case, as you can imagine, your company’s valuation is going to be based almost solely on your team and its ability to execute on its vision — and there’s a very wide valuation range based on those things, notes Joe Floyd of Emergence Capital.
Floyd says that, “On the high end of the spectrum, I’ve seen a proven SaaS entrepreneur raise $15 million at a $35 million pre-money valuation with nothing more than a PowerPoint. On the low end of the valuation range, SaaS startups outside of Silicon Valley without access to a vibrant angel community might raise $200,000 to $500,000 on a $2 million to $3 million capped note.” For the majority of nascent SaaS startups, adds Floyd, “The truth will lie somewhere in the middle.”
Still not satisfied? Maybe this feedback from Alexander Niehenke, a principal at Scale Venture Partners, will help. In his view, the “most rudimentary way to value is a company is at a discount to its future cash flows.” Sure, he acknowledges, many start-ups don’t have positive cash flow today or even expect it in the near future. But many of the value techniques used by investors build on this assumption, he says. “Even a nascent start-up with little to no financial or metric traction has the expectation of future growth and eventually cash flows. Therefore, valuations will be established not based on the nascency of the business today, but rather the expectation of what the business will become in both the near-term and long-term.”
One more thing to note, says Niehenke: It’s not uncommon for a startup to create a unique product — as our reader has clearly done — but valuations are often established by business model or industry. In other words, he says, “If your business model and product delivery is SaaS, a public company like Salesforce is a likely benchmark. If your market is HR software, for example, Workday might be a likely comparable.”
Don’t rely on one or two comparables alone. He advises looking at a basket of them to reduce the variability for any single company. He also advises thinking hard about which companies to use as comparables. For example, he notes, “Using taxi cab companies as comparables for Uber would likely result in an unfairly low valuation [because while they’re] in the same market, they’re very different business.”
You might look instead at similar marketplace business models like eBay or OpenTable, he notes.
Okay, good luck, and founders, send us another question so we can get you some answers tout de suite.Featured Image: phloxii/Shutterstock