I was talking to a very successful entrepreneur recently about valuations of startups as they grow. Specifically, valuation multiples for an evolutionary startup with great revenues vs. a revolutionary startup with good revenues, especially when both are still in early-stage. 

In an evolutionary startup, the product offering is just that – evolutionary. That is, the industry has been moving in this direction for years. The valuation of this startup can be good due to traction, but as an evolutionary company in an established market, competitors will follow and then the evolutionary product becomes substitutable. Its multiple is likely less than 4X.

In a revolutionary startup, the product offering is defining a new space. Getting traction can be hugely difficult like pushing a boulder up a mountain. But once momentum hits, the valuation multiple can be significantly higher due to the meta knowledge and technology surrounding the startup. Yes, a startup doing well in this new revolution will create second-movers. However, proprietary technology and knowledge can be hard to emulate, and with capital, the company can continue to outpace new challengers and drive significant value. 

Being a second-mover has its advantages; namely, requiring less capital to go to market as the first-mover because the first-mover is spending more effort educating the market. However, a well-capitalized, experienced team at the helm of a first-mover can outpace second-movers, and drive up the valuation against second-movers — and evolutionary markets/ companies. For revolutionary products, expect multiples in excess of 6 or 8X revenues.

Consider your next startup idea/ product – is it evolutionary or revolutionary? How will you defend your position and drive up the value of your company and your offering?
I’ve somehow managed to keep this going for four months (including today) researching finance concepts, and blogging about them. Wow, it’s been a great exercise learning and sharing.
I admit my recent blog posts haven’t gotten me THAT excited where I’m openly sharing, but when I started researching and writing this post, I felt that excitement again.
So, anyways… moving on for today’s post – PART 4! The following topics will be covered:
  • Convertible Note
  • Discount (as part of Convertible Note)
  • Cap (as part of Convertible Note)
  • Dividend
  • Pro-Rata Rights

Convertible Note.

A convertible note is kinda, sorta, like-a hybrid of debt and equity financing. Here, the company and the investor delays setting a valuation for the company till a time when the company may raise another round with a valuation. Convertibles are a popular vehicle for early stage startups as it’s hard to discern the value of an extremely young company with little to no earnings.
So instead, the capital at the beginning is treated like a loan upfront. When the company raises another (or official) round, then the outstanding convertible note is converted to equity as a ratio of the valuation. However, to sweeten the deal for the inherent risk of investing early on, there are a couple levers that impact the conversion of the convertible:
  •  Discount – a percentage reduction the convertible note holders can convert to the principal loan amount relative to the purchase price of the next round. The discounts typically range from 0-35% with 20% being the most common. So if Series B round investors are paying $10 per share, the original investors who had a 20% discount on a principal amount of $100,000 can convert this loan amount at a per-share-price of $8 ($10 less 20%)… they’d get 12,500 shares at $8 each but valued at $10 per share.
Seed Round: You invest in a convertible note of…
Principal of $100,000 with a discount of 20% (convertible to Preferred Stock)
Series A: Awesome Venture Capital Firm invests…
$10 per share at a valuation of $10M (pre-money)
Your conversion price-per-share
$10 * (1 – (20%)) = $8 per share
Shares of stock
$100,000 / $8 = 12,500 shares of Preferred Stock
Book Value of stock (unrealized)
12,500 * $10 per share from round = $125,000 (25% unrealized return)
Series A investors would’ve gotten…
10,000 shares for $100,000 investment due to $10-per-share price
  • Cap – a maximum limit of the valuation that can be converted into equity at a later priced round. The investors will typically be priced at the lower of the cap or the valuation of the round. How this works…

Seed Round: You invest in a convertible note of…
Principal of $100,000 with a cap of $5M (convertible to Preferred Stock)
Series A: Awesome Venture Capital Firm invests…
$10 per share at a valuation of $10M (pre-money)
Your conversion price-per-share
$10 * ($5M / $10M) = $5 per share
Shares of stock
$100,000 / $5 = 20,000 shares of Preferred Stock
Book Value of stock (unrealized)
20,000 * $10 per share from round = $200,000 (100% unrealized return)
Series A investors would’ve gotten…
10,000 shares for $100,000 investment due to $10-per-share price


Dividends are disbursements of profits from a company to its shareholders. Dividends are post-tax, and typically abide by a dividends schedule. Though, companies can issues dividends at any time as “special dividends”.
On the opposite end of dividends, companies can also choose to reinvest its net profit into the business as retained earnings rather than issue dividends.
Dividends are more commonly issued as cash to its shareholders. Each dividend is fixed per share, but the total amount will vary depending on the percentage of the shareholder’s shareholding (ownership).

Pro-Rata Rights.

In PART 1, I talked about dilution – the outcome where ownership percentage may decrease when a company raises a round of capital at a higher valuation. Pro-rata rights enables investors from earlier investing rounds to maintain their shareholding percentage and avoid dilution by investing additional capital.
So if an investor invests $500,000 in Amazing Hair Gel Company with a post-money valuation of $2M, the investor has a 25% equity stake in the company ($500,000 / $2,000,000). If the company raises additional capital in a Series B with a post-money valuation of $40M, the investor has pro-rata rights to invest an additional $9.5M to maintain a 25% stake in the company (25% of $40M = $10M with an initial investment of $500,000 already).

Need Your Help Moving Forward!

All of this research has been making me so much more adept and savvy when reading posts about investments and valuations, and also much more knowledgeable talking to others about them. This has been a great exercise, but I think I can do better, but I need your help.
I’ve heard positive feedback so far, and I’m always looking for ways to explain things better. This stuff makes sense in my head as I’m writing it, but it’s largely been one-way communication. That is, I write and “teach” without the student-interaction that makes good teachers GREAT teacher. That is, in 1-to-1 teaching, the teacher (or presenter) and student (or audience) interact with thought-provoking questions. Heck, I oftentimes learn more through these interactions.
Short story – interactions help me learn and explain things even better. So if you have feedback, feel free to shoot me a message on Twitter (@TheDLu) or email so I can explain things better.
Till next month… Cheers!
Onwards and upwards with more finance learnings! Part 3… yes, that means I’ve effectively kept this learning thing going for three months already. I’ve learned a ton about finance itself, and some of its roles in startups.
At the end of Part 2, I noted a few points I wanted to dive into with more detail. So today, I’ll cover a handful of them including:
  • Pre-money and post-money valuation
  • Earnings-per-Share
  • Equity Financing
  • Debt Financing

Pre-money and post-money valuation.

In Part 2, I touched on a lot of stocks and investments by VCs. Simplistically, the equity a VC receives in exchange for funding is:
Except, valuation can also be parsed into pre vs. post-money valuation. You can probably guess what these terms mean, but they can have a big difference in equity. Pre-money refers to the valuation of the company BEFORE the injection of capital; whereas, post-money refers to the valuation of the company INCLUSIVE of the investment round. For example…
Pre-Money Valuation
Post-Money Valuation
Hugh Invests
Valuation of Company at Investment
Valuation After Investment
Hugh’s Equity %

What’s happening? As you can see, if Hugh invests $10M at a pre-money valuation, the company is then valued at $60M after the investment. Hugh’s equity stake is 16.7% because the company is valued at $60M ($10M + $50M) à$10M/$60M = 16.7%.
With a post-money valuation, Hugh is investing his $10M into a company valued at $50M which is already including his investment. Thus, Hugh has a 25.0% equity stake in the company.
8.3% can mean a lot of money on the table for either side – the investor or the company when going public or some other liquidation event.


Ah, another pretty “straight-forward” financing metric. Straight-forward in that its name is exactly what it is… “earnings” per share; where share is the number outstanding shares. Note: outstanding shares is the number of shares issued to company officials, stock holders, etc.
Earnings is the net earnings less taxes and dividends paid out to preferred stock owners (recall from Part 1 that preferred stockholders receive dividends before any other common stockholders).
EPS is a metric used as a gauge for how well a company is performing, and evaluate the performance of a company to its shareholders.

Equity Financing.

Mostly up to now, I’ve shed more light on equity financing. In the startup world, equity financing makes the headlines like Yik Yak raising $61M or BitPay raising $30M back in May 2014.
As a recap, with equity financing, companies are exchanging ownership in the company for capital (and partnership). As equity investors are investing on the potential upside of future success, they may be more lenient on recent financials with an eye on the future. Further, there usually isn’t a fixed return to investors which frees up working capital for the company. However, investors, as owners of the company, do usually get a share in the profits and have a say in the direction of the company.

Debt Financing.

Debt financing is very common place in everyday life ranging from homes, cars, and of course, businesses. In debt financing, loaner and loanee (the company) agree on a principal amount + interest to be returned on a period basis for some time (or when the note (another word for loan) is paid up).
The principal and interest can be marked as a fixed cost which raises the break-even point of a company (costs + revenues = 0; costs = revenues). As you can imagine, this can be a significant burden on a company’s cash flow, and thus, loaners typically require strong financials in addition to credit.
On the upside of debt, the company does not give up ownership in the company, and thus, the company maintains all profits (present and future) as well as the direction of the company. Also, interest on the loan can be tax-deductible for the company.
There’s obvious upsides and downsides to both equity and debt financing. Making that decision is hugely dependent on a myriad of factors for the company.

Onwards to Next Month

Here’s the open list of topics for me to research and share starting next month. Happy I knocked a few off the list from last month.
  • Convertible
  • Dividend
  • Pro-rata
  • Leveraged
  • Term Sheet
  • Etc.

What questions, thoughts do you have about the above? Any other topics from a startup’s finance point-of-view you’d be interested in learning more about, and having me research for you?
Resources: http://www.investopedia.com/ask/answers/114.asp,  http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/earnings-share-eps-1003, http://www.investinganswers.com/financial-dictionary/stock-market/shares-outstanding-3594
Source: http://ak8.picdn.net/shutterstock/videos/1256950/preview/stock-footage-man-in-brown-suit-stand-on-beach-and-rises-hands-then-walked-and-immersed-sea-water-and-swam-at.jpg
I’ve been heads down trying to get this new startup I’ve got going that for one of the first times in a while, my mind was drawing a blank as to what I should post about. I’m not quite where I want to be for the startup to post anything about it, yet, so I’ll curb that. Instead, I did read an article recently about the CEO of MongoDB, Max Schireson stepping down.
MongoDB is one of the hot techs out there right now. When you think up-and-coming and leading edge tech, it’s right there at the top with a recent valuation of $1B according to the article on Business Insider – Why This CEO Happily Just Quit The Best Job He’s Ever Had.
Schireson cites his crazy travel schedule considering he and his family lives in Palo Alto while the company is headquartered in New York. He’s on course to break 300,000 miles this year! (As a former frequent flyer (Delta Diamond, for the win) and now sparse traveler, ah, I want that.) Anyways, he’s leaving the post and stepping into a Vice Chairman role.
His blog post describes more of the situation, and based on some questions and lifestyle choices of those around me are playing out, I wanted to share some take-aways…
  • For Max Schireson and many, family comes first.As a young consultant but always a “family man”, I used to ask the more senior consultants how they felt about traveling during the rapid growth years of their young kids.
  • Not always about money, especially “now”. When you’re good at what you do and you know people, you’ll likely always have opportunities that will pay you. Money’s not really the problem. For me right now, my focus is less on money and more on entrepreneurship and building a startup that will have lasting impressions. If things really do slip for me, I know I can pull the ripcord and parachute to “security”.
  • Some/ most people won’t understand why, but you only need a select few to know why. That is, MongoDB is growing by leaps and bounds. They’ve raised some serious capital and have a hotly rising valuation. Schireson’s step down from CEO will impact him not just on the bottom line, but also from professional development, etc. perspectives. Most people will see it that way. But to those who matter, they’ll understand and support him on his decision and transition (and beyond).
  • If you’re running a company, you need “all-in” leaders to make the most of the opportunities. Maybe you need to mitigate some risks at the beginning, but once that’s rolling, you need to plunge headfirst to make the decisions and adjustments (pivots?) necessary to the business to be successful. It’s like raising a baby!
  • Plenty of bias and judging between men and women executives. The start of the Business Insider article talks about Schireson’s experience of questions asked of him vs. his female executive counterparts regarding “personal interests” vs “family-work balance”.
  • Behind every great business leader, is a great partner. I remember watching a video of the trials and tribulations Elon Musk endured during the formative years of both Tesla and Space X (see his 60 Minutes interview). However, he also had a great partner at home in his wife to take care of the “Personal Business”. Looking at those around me like at Body Boss, Don (our Head of Development/ Lead Developer/ Make Sh!t Happen Officer) worked some crazy hours after his full-time gig, and was supporting a newborn. His wife was a huge, HUGE partner of not just him, but for Body Boss because of her support.

So in the end, Schireson’s making the decision that he and his family feel is best. It’s been a great run at the helm of MongoDB, but it also doesn’t mean his role in shaping the company future stops and that he just stops moving forward professionally. Instead, now, he can move forward in the capacities he views as most critical to his greater LIFE – his family.
What are your thoughts about stepping down or away from seemingly highly lucrative positions? Schireson obviously holds his family as the main pillar of his life. What would you say is yours right now?