If you’ve been keeping a tab on the IPO valuations over the last month or so it almost seems like billion dollar valuations have become the norm.

Zynga $5.5 billion

Linkedin $2 billion

Groupon over $6 billion

It makes you wonder if your own estimate for valuation of your own startup or funding requirement is too conservative. That could be whimsical thought! While it’s easy to compare with the big ventures that have made headlines, most startups are better off looking internally on a more grounded level to get a more accurate valuation and set their funding expectations accordingly.

First of all companies like Zynga, Linkedin and Groupon have been around for some time and have massive user bases so proof of concept, revenue model, adoption and traction are words their investors need not even factor in while valuing the business. For most early stage startups however, most standard business valuation methods are an estimate at best and there aren’t as many tangible measuring sticks to go by for investors.

As a result, there’s often a disconnect between the way a startup founder sees the value of his/her startup and how investors see it. This leads to founders feeling that what they have is being undervalued and investors are asking for too much equity share for their investment while from the investors vantage point, they feel there isn’t any tangible proof of success and it wouldn’t be worth the risk for a smaller share of the equity.

A useful yard stick for entrepreneurs is the ‘pie formula’ of deciding what equity to give to an investor. If a startup feels that the investor will add more value to business than the equity is he asking for it, then the startup may well accept it. For e.g. If an investor is asking for say 10% equity, and you feel that with his expertise, network and funds – he can actually take the potential valuation of your business much above the rate of 10%, then you may not hesitate in offering that equity to him. If that is not the case however, then you may need to further negotiate.

To understand what constitutes a fair expectation from an angel investor and how much is your startup valued at, it’s important to identify what phase you’re startup is currently in :-

1st – Idea stage / Concept Stage / Business Plan Stage /
2nd – Technology Developed / Working Model Stage / Pre Launch
3rd – Launched Product / Early Adoption / Building Traction Stage
4th – Scaling / Growth / Adoption Stage
5th – High Growth / Business Expansion Stage

At the first stage valuation purely using traditional methods is nearly impossible and largely dependent on belief in the plan, the team and potential of the startup to grow from a concept or plan to an actual business venture. The risks are inherent and the investor would need to have the upper hand while structuring a deal at this stage. As an entrepreneur it’s more likely that you would be giving up more equity at this stage and it may not always be realistic to assume that you can get an investment in exchange for a very small percentage of ownership.

At the second stage, there could be a little more confidence from investors since you have a working product or prototype making it easier to visualize the value and prospects that could emerge from the venture. Depending on the investors belief in the product and the team that there will be adoption and growth with the prospect of scaling it into a full fledged business, the leverage is more or less even with both parties being able to negotiate and structure a deal that suits everyone.

From the 3rd stage onwards, the entrepreneur has a little more leverage with the ability to show some initial interest, customers, adoption and a more realistic valuation becomes possible. A founder can expect to give away perhaps a little less equity and an investor would be more assured of significant returns in the coming years going by what has been achieved so far.

While most of us will still dream about valuations and deals like the Zynga’s, Linkedin’s and Groupons of the startup world, by determining where you stand in terms of what investors can tangibly witness and setting expectations accordingly, you can arrive at a valuation and funding requirements a little closer to home.