Many companies quote the valuation that they raised money at the last round as a proof of what they are worth, many accelerators etc also do this. Nothing wrong with this but BE AWARE as an investor to not be sucked in.
Valuations in private companies are ok but only part of the equation of the true worth of a company. The real game is being played in the term sheet and preference shares.
Preference shares allow an investor to have a nice clause that restricts the downside. Lets play an extreme example:
– Investor A invests £1 million at a valuation of £3 million with a preference that in all cases they get the first £2 million out in a deal.
– The company exist for £2 million
– Investor A gets £2 million ( 200% return ), Founders get zero, any other investors get zero
Play this out with several rounds of funding:
– Investor A invests £1 million at a pre money valuation of £3 million with a preference that in all cases they get £2 million out in an exit scenario. Founders now hold 75% of the company
– Investor B, next day invests £2 million at a pre money valuation of £6 million with a preference that in all cases they get £4 million out in an exit scenario. Founders now hold 51.25% of the company
– Investor C, next day invests £4 million at a valuation of £12 million with a preference that in all cases they get £8 million out in an exit scenario. Founders now hold 38.4375% of the company
– Total invested £7 million, Founders own 38.4375% of the company
Now the companies growth is flat, the investors control the board and the company has an offer for £14 million
– The company exits for £14 million
– Investor A gets £2 million ( 200% return ), Investor B gets £4 million ( 200% return ) Investor C gets £8 million ( 200% return ), Founders get zero, any other investors get zero
Cheers
Doug
Terms matter – make sure you understand them
Cap tables don’t tell the real story