Thoughts on startups by investors that
fund them & entrepreneurs that run them

Valuation Part I: Peeling the Onion, or How Top Investors Value the Startups They Invest In

Early-stage technology company valuations are generally a crap-shoot. Bill Payne did a great post about this in October 2011. This post builds on top of his work, and attempts to shed additional light on the valuation process.

New founders may think that startup valuations work like this:

  • I figure out what the value of my existing company is
  • I figure out how much money I need
  • I give the % away equal to: money needed/(valuation + money needed)

In reality, valuation is a process of reducing layers of risk. Each layer is a different kind of risk, like the layers of an onion, and investors are trying to peel off the layers to evaluate the opportunity (analogy courtesy of Marc Andreesen). So, it looks more like this:

  • Founder convinces investors that they are investor-ready (“peels the onion”)
  • Founder convinces investors they need $X (where X typically equals $500K – $2M for the first priced round)
  • Investors ask for 15% – 25% post-money (and get more depending on how well they can negotiate)
  • Valuation ends up being calculated (e.g. $1.5M investment/20% stake = $7.5M post-money)

As Marc mentioned in a great how-to-start-a-startup video, investors think about a company’s valuation in terms of risk and rewards. Effectively, they think about value as the inverse of risk. The more layers of risk your company has, the lower valuation you get. The more layers of the onion that have been peeled away, the higher your company valuation.

startup company valuation

What the onion model implies is that if you have a weak team and the “economic trends” don’t make sense, but you have high market traction (insert Instagram, Snapchat, Facebook), then your valuation won’t be affected by your team or business model. Your valuation can remain high. Alternatively, if the market opportunities are excellent and you have the best team, but you just can’t get a product to market, then your valuation will remain low.

To assess your own layers of risk, look at the six main categories, or vectors, that investors look at when valuing a company. As depicted above, these are:

  1. Opportunity Size (Total Addressable Market, direction of market)
  2. Team (composition, execution experience, subject matter expertise, professional network)
  3. Development (sweat equity, skin-in-game, milestones completed)
  4. Competitive Advantage (approach vs. pricing vs. technology vs. network-effect)
  5. Traction (eyeballs, customers, revenue, earnings)
  6. Distribution (repeatable processes, recurring earnings)

You can get a better sense of where your company is positioned by first placing your closest (funded) competitor on each vector. An example would look like this:

startup company valuation map

The scale goes from 0 to 100 where 0=Weakest position and 100=Strongest. Assign yourself a position relative to your competitor, as shown on the above vectors.  The columns should be divided into Your Company results and Competitor results, similar to the table below.

startup company valuation

Once you have established your scale values, divide them to get your Relative Values. Multiply each of those by Bill Payne’s corresponding Vector Weights, add them together and multiply the sum by your selected competitor’s pre-money valuation. The Vector Weights are relative to your business and can be independently adjusted but should always add up to 100%. If you set a value below its maximum you can add more value to another vector (i.e., if Traction isn’t important to you and Team is, set Traction to 0, and add 10% to Team).

To make it easy, you can use this pre-money valuation calculator to do the work for you. The calculator will also generate the above Valuation Vector Map.

As a founder, focus on showing that you have peeled away the risks and that you have a plan for the money. It’s much easier to raise money with a peeled onion than with a fancy financial model attempting to prove your value.

Keyvan Firouzi, CFA is Principal of Preferred Return.

Written by Keyvan Firouzi

user Keyvan Firouzi

Keyvan Firouzi, CFA is Principal of Preferred Return.

prev next

You might also be interested in

What Belongs in a Startup’s Pitch Deck?

So you’ve developed a game-changing product, formed a business with a killer team, quit your job, and are rolling the product out to market. Your business is the next unicorn, and all is good in the world. Fantastic. Now only one thing is inhibiting your company’s growth: you have no money.

For many founders of high-growth startups, bootstrapping has limits.

Read more >

From Accelerators to Venture Capital: What is best for your startup?

With startup growth up 61% since 2014 and more investment programs emerging, it can be overwhelming for founders to know just where to jump in. As the most startup-friendly accelerator on the planet, MassChallenge has helped 835 startup companies around the world, who have raised over $1.1 billion in funding and created over 6,500 jobs. We have seen startups at

Read more >

Ask A Founder: Startup Lessons Learned from Work Truck Solutions’ Kathryn Schifferle

Kathryn Schifferle, Founder and CEO of Work Truck Solutions, turned being a woman in work trucks into an oversubscribed $2.1 million round.

We sat down with Kathryn as she shared what her fundraising journey was like, the startup lessons she learned, and her advice to fellow founders, especially women. Here is what she had to say:

HK: Tell

Read more >

Ask A Founder: Startup Lessons Learned from Squareknot’s Jason Rappaport

Jason Rappaport, Founder and CEO of Squareknot, has raised $1.3 million to date — his first $500,000 round came after a single email, pitch, and lunch.

We sat down with Jason as he shared what his fundraising journey was like, the startup lessons he learned, and his advice to fellow founders. Here is what he had to say:

HK: Tell

Read more >

Ask A Founder: Startup Lessons Learned from Planitar’s Kevin Klages

Kevin Klages, Co-Founder and CEO of Planitar, raised a $500,000 seed round after four pitches to angel investors.

We sat down with Kevin as he shared what his fundraising journey was like, the startup lessons he learned, and his advice to fellow founders. Here is what he had to say:

HK: Tell me a little about Planitar. How

Read more >