Venture Capital

What’s the base rate for your seed round valuation

The discussion of valuation and price is never simple. For the Venture Capital sector - as Prof. Aswath Damodaran explains in this article — the subject is still not conceptually clear; it is even more complex the earlier the stage of the company is. Now imagine how it is for the founders and VCs in the context of the seed round.
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What’s the base rate for your seed round valuation
What’s the base rate for your seed round valuation

Photo by Bud Helisson on Unsplash
Halston: You were right about one thing though. I did sell my name.
Joe: Oh sweetheart, I was just teasing you about that.
Halston: We're given one name, Joe. Just one. And that's all we have while we're on earth. And it's all we leave behind when we're gone. I wasn't precious enough with mine. And I sold it cheap. I didn't even think twice about it.
Joe: Hundreds of millions of dollars ain't cheap, Halston. (isn’t selling yourself cheap, Halson)
Halston: It sure is, Joe. You know how I know? I'd pay twice that to get it back!

I (freely) extracted these lines from the great Netflix series Halston, a conversation between the legendary designer of the 1970s and 1980s and his creative co-founder, Joe Eula. What caught my attention was how well it exemplifies the complex debate between price and value. For Halston, the sale of the company that bears his name was cheap. In other words, the price he got was lower (apparently half) than its value, a view that Joe does not necessarily agree with. So who's right? It's hard to say, because value is relative for rational and irrational reasons. Here are some examples:

  •  Irrational: the endowment factor. According to studies of the endowment effect, the simple fact that you own something already induces you to think that it has more value than a comparable item. Just think: in Halston's case, the company carried had his name;
  •  Rational: specific knowledge of the business. As he participated in the company's development, he considers himself more apt to extract value from that machine than outside buyers, regardless of whether they are from the same industry and/or more experienced. Let's not forget that the fact that he considers himself does not imply that it is true, but follows a rational line given the situation.

One additional piece of information would bring more clarity to this debate: what were the terms of sale (price) of similar businesses to the Halston company, both historically and in that year?

Connecting the above debate with my previous article, the discussion of valuation and price is never simple. For the Venture Capital sector - as Prof. Aswath Damodaran explains in this article — the subject is still not conceptually clear; it is even more complex the earlier the stage of the company is. Now imagine how it is for the founders and VCs in the context of the seed round. Let's think about a possible scenario (among infinite possibilities):

  •  Founder: His checklist for the round is almost complete, he has a beautiful spreadsheet projecting exponential growth, he's finalized a pitch deck using Astella’s framework, he knows how the partners' meeting at the VC works, he's thought about how he will justify the higher-than-average ticket in that round, and thoroughly rehearsed his narrative on the vision of the forest they're going to cultivate, starting with these first trees. This madman's drive comes from the courage to pursue the dream of being an entrepreneur and being successful, despite all the difficulties and the high mortality rate among startups;
  •  VC: He studied the pitch deck to get the most out of the conversation, analyzed the profile of the founders, prepared his inside views on the theme based on in-house experiences and the feedback he got from experts in his network, listed points on how to help the startup's development (whether or not chose to move forward) and refined the narrative of his firm (that receives 1000 startups a year, but invests in just five). This group's drive comes from the courage to make such risky investments, hoping for long-term compensation, combined with the honor of helping the true heroes of the journey, despite them being entrepreneurs in a business that is governed by a power law (few cases that pay the bill and justify the sector).

The dance above is expected and rehearsed as it becomes helpful for discussing the most complicated variable in reaching an agreement: the valuation of the startup. To begin with, a market base rate helps anchor the conversation to discuss the reasons (speed of revenue growth, quality of the founders, NPS of the product, TAM,metrics specific to the business model, contractual terms, etc... ) for the company's valuation to be higher/lower than this reference. The difference in value perception most probably will continue, but at least it’s a starting point (price per share) to make the relationship between the parties official and help everyone work in better alignment for the development of the forest (value creation) after the deal is concluded.

So let's check out the data.

Before our conclusions, here are some information about the data and analysis:

  •  Pitchbook’s base has 82% more valuation data for the seed round in the period studied, even when only considering the U.S. (likely the reason it's so much more expensive);
  •  We're using South America as a proxy for Brazil, due to the greater amount of pre-money valuation data reported.

Some conclusions & inferences:

  •  Once again, the U.S. market, on another level, indicating that it is at least 60% higher than that of the world considering the historical median;
  •  South America's average compound annual growth has been lower since 2010. Due to the low representativeness, it is more likely that we will keep following the pricing of other places, adjusting the rate of growth;
  •  In line with the ticket for the round, the relative fundraising premium for pre-money valuation is much higher here and in the world than in the U.S. In other words: given the dispersion of data reported comparing the groups from the 1st and last echelon over the median, good work in capital raising makes more of a difference in our ecosystem than in the reference market, the United States. Once again, it reinforces the importance of this process in developing your startup with the least possible dilution during the journey.

Now we have an explanation of the base rate framework using the context of the seed round for the ticket and pre-money valuation variables. Based on the premise that this investment in information transparency will improve the relationship between founders and investors, I will begin a journey to update the seed and series-A data on a monthly basis. Confident in its usefulness in our ecosystem, I am prematurely thrilled that this exchange will generate ideas and hypotheses for us to search the data for indications of possible paths we can move forward together. Until next time!

This text is part of a series of analyses of Venture Capital investments using base rate concepts. In the last one, I analyzed and compared investment checks in Seed rounds in Brazil, the United States and the World.

Cassio Azevedo (EN)

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Cassio Azevedo

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