Many entrepreneurs want to put a value on their company before the ink on their incorporation documents is dry, but valuing an early stage company is as much art as science, and a bad valuation can be worse than no valuation at all.
Valuing a company that doesn’t yet have a product on the market, much less paying customers, involves a lot of guesswork. Even if there are good comparables available (ideally other companies at a similar stage of development with similar products that recently received financing at a known valuation), it is hard to extrapolate from those comparables to determine the valuation of your company because you have different technology, a different product and different people. And, of course, there is the entrepreneur’s natural bias that inevitably sneaks into the valuation.
Because of all the variables and uncertainties, companies are often better off if they avoid setting a formal valuation at the outset. If the company needs to raise seed money before seeking venture financing, it may be preferable to do so through a convertible debt financings, which allows the company and the investors to put off the question of valuation by providing that the debt will convert to equity at the per share price (often less a discount) established at a later equity financing. In this way both the company and the seed-stage investors can piggy-back off the valuation analysis conducted by an institutional investor at a later date.
If you do need (or feel compelled) to establish a valuation early on, it is important to be realistic and not get too attached to your number. A VC will conduct its own analysis, independent of your valuation, to arrive at a value for your company. If you try to insist on a valuation that the investor believes is too high, it will be an impediment to getting the deal done. This doesn’t mean you should never push back on the investor’s valuation, but remember that valuation is just one of many terms in a financing that impact the future value of your ownership in the company.
Finally, please note that the Internal Revenue Service has detailed guidelines concerning the factors and methodology for valuing early stage companies. Failing to abide by these guidelines can have significant negative tax consequences, so it is important that you consult with your legal and financial advisors whenever you undertake a valuation.