Ending Soon! Save 33% on All Access

How to Navigate the Choppy Waters of Startup Valuation In a landscape where down rounds are rising and a good business idea doesn't always equal financial gain, entrepreneurs must navigate the tricky waters of valuation with a clear-eyed approach to secure the funding they need.

By Jordan Gillissie Edited by Chelsea Brown

Key Takeaways

  • Emotional attachment to a business can lead entrepreneurs overvaluing their ventures, especially in a competitive funding landscape.
  • Objective assessment of a venture's worth is crucial, considering the increase in down rounds and the importance of demonstrating a clear pathway to profitability to investors.
  • Entrepreneurs must prepare for funding rounds by clearly articulating the benefits of investing in their venture, understanding the story behind the numbers, being mindful of investment terms and staying informed about market trends.

Opinions expressed by Entrepreneur contributors are their own.

Entrepreneurs often have a deep, personal investment in their businesses, having dedicated years of hard work to bring their ideas to life. However, this emotional attachment can cloud their judgment and make it difficult to objectively assess their venture's worth. They might find themselves attempting to translate personal effort, time and sacrifice into financial value, which can be problematic in the current environment.

Though Series A investment activities have been stable as of late, there's been an uptick in down rounds. According to PitchBook and J.P. Morgan, down rounds grew from 8% in 2022 to 20% in 2023. That means less money is coming in than normal, which means more venture-backed startups are on the hunt for capital.

Complicating matters further is the valuation process itself. Many new businesses mistakenly set their value based on competitors, using similarity of goods or services to estimate worth. This type of comparison overlooks differentiators, such as operational, financial or execution risks. Failing to consider milestones that you've yet to achieve can lead to the misconception that all is equal.

It's important to remember that a competitor's current valuation is the result of their unique journey, and yours will be something entirely different. The challenge is separating personal bias from objective assessment, as you'll need a clear-eyed view of what your business offers to arrive at an accurate and realistic valuation.

Related: What Every Founder Needs to Know About the Valuation Gap Between Entrepreneurs and Investors

Preparing for a funding round

Merely launching a great business doesn't automatically mean it's ripe for investment. The fundamental economic principle behind raising capital is that the injection of outside funds should fuel growth and increase the value of the business, creating the potential for investors to see a return on investment. It's not like investors invest out of the kindness of their hearts (at least, most don't). They want to see a clear pathway to profitability. The question then remains: How exactly do you prepare for those inevitable funding rounds? Here are some suggestions to get you started:

1. Demonstrate the "why"

Rarely, if ever, will it be enough to simply offer a piece of the business to potential investors. When angling for funding, it's important to articulate the precise benefits of backing your venture. This is especially important in light of the 30% drop in startup funding in 2023, according to Reuters. You should be able to answer at least these questions: Why should anyone invest in your business? What's the economic rationale for the investment? How will an investor make money?

Whether it's an ambitious tech innovation or a noble cause, go beyond the vision or mission of your company and present a plan that clearly shows how you intend to use the capital to achieve specific milestones. That means focusing on practical financial outcomes, which increases the chances that potential investors see a pathway to profitability. They also get a better understanding of the mechanisms in place for monitoring progress and achieving an exit. This clarity in the potential for financial return is what can make the difference in securing much-needed funding versus never getting a meeting.

2. Understand the story behind the numbers

In the context of venture capital and private equity, a compelling pitch will only get you so far. Rather, securing funding is more about what the concrete numbers reveal about the profitability of your venture. Profit margin, for one, offers insights into your company's financial health and potential for growth. The same can be said for customer lifetime value, cost structure and revenue.

For example, when my firm evaluates a business, understanding the cost of capital in the current market is crucial — even more so if we encounter a startup with an unclear equity distribution or no significant personal financial contribution. The issue arises when such a company claims that it's worth a substantial amount, say $1 billion, without a defensible rationale. In other words, always provide tangible evidence that the hard work put into building the business translates into something of real value.

Related: How to Get Funding: The Dos and Don'ts of Raising Capital From Investors

3. Be mindful of investment terms

One aspect that entrepreneurs often overlook is the concept of "toxic minority control," which refers to the disproportionate influence or power held by minority shareholders. Should some disruptive investor buy up enough shares to secure a place on the board, it could potentially lead to adverse outcomes for the venture and other investors. You need to be mindful of this when raising capital, as the terms of investment can have far-reaching implications beyond the immediate influx of funds.

Take Alphabet Inc., for example. Even though Larry Page and Sergey Brin own just 5.7% and 5.5% of the company, respectively, the two Google co-founders each own Class B shares, or "super-voting" shares, providing them with 10 times the control — or 51% of the votes, collectively. Meta and Walmart are other examples of companies with founders (or the heirs of founders) who still control the business even after the initial public offering.

4. Never underestimate (or overestimate) market trends

Though this should go without saying, where the market is headed can significantly influence your startup's valuation. You need only look to last year for an example of that, with generative AI and AI-related startups raising nearly $50 billion in venture capital, per reporting from Crunchbase. However, don't make the mistake of benchmarking yourself against corporations listed on the stock exchange.

While market trends certainly make one startup more attractive than another, being in the same industry doesn't equate to having the same value. Consider the nuances of your company's stage, market position and operational history in relation to those operating in the same space. PitchBook and Y Combinator are both great resources, as they regularly publish statistics on the average valuations of amounts raised for different funding rounds. Understand where your company truly stands in terms of where the market is headed, as well as your market reach and status, to arrive at a realistic valuation of your venture.

Related: 6 Parameters That Determine Company Valuation

Entrepreneurs often begin with an idea and believe that its mere conception is equivalent to its potential realized. They look at the end goal, which can lead to unrealistic valuations. What truly matters, at least in the eyes of investors, is the ability to execute on that idea, which comes down to the numbers. Get clear on your standing, and then let that guide your discussions with potential investors.

Jordan Gillissie

Entrepreneur Leadership Network® Contributor

Founder & CEO of Equifund

Jordan Gillissie is the founder and CEO of Equifund, an alternative investment platform that provides retail investors with access to emerging companies. Registered with both FINRA and SEC, Equifund is dedicated to empowering entrepreneurs and educating investors.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Business News

TikTok Reportedly Laid Off a 'Large Percentage' of Employees as the App's Fate in the U.S. Remains Unclear

Laid-off TikTok employees were notified Wednesday night through Thursday morning.

Personal Finance

This Investment Bundle Includes a Trading Course and Stock Screener Tool for $150

Approach the stock market with an increased understanding.

Business News

Four Seasons Orlando Responds to Viral TikTok: 'There's Something Here For All Ages'

The video has amassed over 45.4 million views on TikTok.

Growing a Business

5 Strategies to Know As You Scale Your Business

Scaling a service-based company requires a comprehensive approach that goes beyond simply increasing revenue. It requires careful planning, strategic decision-making and a deep understanding of market dynamics.

Growing a Business

The Right Way to Ask Someone for a Million Dollars, According to a Fundraiser Who Does It For a Living

No matter what you're raising money for, Wanda Urbanskia says, the same basic rules apply.