In the world of startups and investments, valuation isn’t just a number, it’s a strategic tool. Today, we’re decoding the valuation trinity (copyright pending) - the three most common approaches to valuation found in investment documents. Let’s dive in!
What’s valuation trinity?
Valuation trinity unites the three most common approaches to setting valuation in current or future funding round.
Fixed valuation: This approach pins down the exact company value at a given time. Fixed valuation can be found both in convertible loans and equity rounds.
Valuation discount: Valuation discount lets an investor get company shares with discount in following rounds. Discounts typically range from 10-30 %. You’ll see this trinity member in convertible loans rounds.
Valuation cap: Valuation cap limits the price at which an investor’s note can convert into equity in a qualified round. This protects the investor against a huge increase in company valuation in future rounds. Again, you’ll find valuation caps in convertible loan investments.
Let’s illustrate on an example, shall we?
Our test company has a valuation of $10M in Round 1 and raises $1M. Then, there are two scenarios for Round 2, one successful and one down round. Let’s assume the founder owns 100 % of the company before Round 1 and all numbers are in post-money valuation (understand what’s post-money here).
Let’s see how much equity our founder owns in each scenario based on the valuation approach they chose.
Why does this matter?
Put simply, the valuation trinity defines how much equity your investors will get in a qualified round. As a founder, you need to make sure you understand the conversion mechanism so that you have control over your company’s equity.
Dos and don'ts
Setting up your valuation can be tricky, but we've got some simple tips to help you.
In a nutshell
The valuation trinity decides how much equity your investors will see in qualified rounds. It’s all about maintaining a balance - you need to have control over your equity, but you also need to be fair to your investors.
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