How Venture Capitalists Value Startups
Welcome to another edition of The Valuation Story
I am hoping you are fine and shine with your family
First, we understand what VC Method.
The VC Method values a startup by estimating its future value (using revenue projections and industry multiples), then discounting it back to present value based on the investor's required return. This helps determine how much equity the investor should receive for their investment.
Imagine you’ve built a startup. You’ve spent the last year developing an incredible antivirus software. It’s faster and more effective than anything on the market. You believe in it, and so do early users. You launched a beta version for free, and people are loving it.
But there’s a challenge—your company has no revenue yet. You’ve only been in business for a year and have spent $1.5 million on development. You now need $30 million to launch the product commercially, expand your team, and grow fast.
A venture capitalist (VC) is interested in investing. But before they do, they need to answer an important question:
How much is your startup worth today?
This is where startup valuation comes in. Let’s walk through it step by step.
The first thing the VC wants to know is: What will the company be worth in the future?
Since your software is gaining traction, you estimate that in three years, revenue will reach $300 million. But how does a VC know if that number is good?
To figure it out, they look at similar companies in the market. The best comparison is publicly traded antivirus companies, like Symantec and McAfee. These companies have already been valued by the stock market, so we can use them as a benchmark.
One way to compare companies is by using a multiple called EV/Sales (Enterprise Value to Sales Ratio). This tells us how much investors are willing to pay for every dollar of revenue in that industry.
For Symantec, this ratio is 1.67x
For McAfee, it’s 2.88x
The median multiple for antivirus companies is 2.28x.
This means that, on average, investors are valuing antivirus companies at 2.28 times their annual revenue.
If your startup reaches $300 million in revenue in three years, we estimate its value by applying the same multiple. This gives us a future valuation of around $682.89 million.
But that’s three years from now. The VC is investing today, so they need to figure out what your company is worth in the present.
Now comes an important concept: discounting the future value.
Venture capitalists take big risks by investing in early-stage startups. Since most startups fail, they expect very high returns—typically between 30% and 50% per year.
Let’s assume the VC wants a 30% return every year. To estimate today’s value, they adjust the future valuation backward, meaning they calculate how much the company should be worth now to justify that level of return.
After doing the calculation, the VC estimates that your startup is worth $310.83 million today based on the industry standards and their expected return.
Now, let’s figure out how much equity the VC should get in exchange for their investment.
They are offering $30 million to fund your business. But what percentage of the company should they receive in return?
There are two ways to look at this:
1️⃣ Pre-Money Valuation – This is how much your startup is worth before the investment. The VC calculates that your company is currently worth $310.83 million. To find out how much ownership they should get, they compare their investment amount to the total pre-money valuation. Based on this, they would receive 9.65% ownership of the company.
2️⃣ Post-Money Valuation – This includes the new investment. Once the VC invests $30 million, the total value of the company increases to $340.83 million. Now, when we calculate the VC’s ownership based on this new valuation, it comes out to 8.80% ownership.
So, after the deal, the VC officially owns 8.80% of the company.
Why did their ownership percentage decrease from 9.65% to 8.80%?
Think of it like a pizza. 🍕
Before the investment, the VC was getting a 9.65% slice of a smaller pizza. But once they invest, the total value of the company increases—it’s like making the pizza bigger. The VC's slice remains the same size, but because the overall pizza has grown, their percentage is now smaller.
This is why startups try to increase their valuation before raising money—so they can give away less ownership in exchange for funding.
Let’s recap what we learned:
1️⃣ We estimated the future value of the startup using industry benchmarks ($682.89M).
2️⃣ We discounted it back to today using a 30% target return, resulting in a $310.83M valuation.
3️⃣ We calculated the VC’s ownership:
Pre-Money Equity: 9.65%
Post-Money Equity: 8.80%
This is how the Venture Capital Method works. It’s one of the most common ways investors value startups, especially those that don’t have revenue yet.
Now, let me ask you:
If you were the founder, would you accept this deal? Or would you try to negotiate a higher valuation to give away less ownership?
Thank you for reading
Signing off
The Valuation Story