How do startups figure out their pre-money valuation when when talking to investors before their company is making any money?

I'm both an active angel investor and entrepreneur who has recently raised capital.

I'll start with what is standard in Silicon Valley and then apply various multiples and discounts where relevant.

For an angel or early seed round, the current going rate is $3m-$5m pre-money via a capped note or priced round. Priced Rounds typically most often use the "Series Seed" docs and Convertible Notes typically are 18-24 month terms with a 15% discount.

I don't mean to be argumentative but Marco is incorrect that valuation can be avoided by a capped note. And in general, there is no way to avoid setting a valuation except via an uncapped note, which is almost unheard of. Setting your cap and discount will have a significant impact on your cap structure, the same (and in some cases) worse than a priced round.

This $3m - $5m range is what I'd call current market value in the valley for "ideation-stage" capital. This is that there is a team in place, typically some form of MVP and in some cases some very basic market data supporting the general thesis of the raise.

In the other market I'm familiar with (Canada), the range for the same stage of capital is $1m - $3 with most being in between $1m and $2m and most preferring priced rounds over notes.

These rounds rarely have a real lead since the raise is typically $500k or less, so if you price it reasonably, most (good) angels will accept the terms as is.

The low and high end of the ranges are discounted and pushed by the credibility presented most often by the team (done it before, worked for a notable company, had some relevant success) or strong evidence of the thesis being correct. It's also the Founder's option to price the round at the top end of reasonable or provide what you might consider a discount, depending on the kind of investors you are courting.

So while this is what I'm seeing as "current market conditions" there is price elasticity in any market. The best way you know if you've priced it right, is if people are buying. Any angel investor should be able to give you a conditional answer after the first meeting (subject to playing with the product, reading terms, meeting the rest of the team). Any angel investor in ideation stage capital who can't give you a yes, no or subject-to yes in the first meeting is not worth pursuing IMO. Any investor who can't close within 3 meetings or conversations won't close (9 times out of 10).

Happy to talk to you about the specifics of where you're at, what might help you improve your odds and generally get you closer to the point where you're ready to raise.

There are many formulas, my advice is at a very early stage try to avoid the valuation.

If you are seeking a seed round, you can avoid the valuation question by structuring your investment via a convertible note (with or without a cap).

If you really want to assign a valuation (it will work against you). It will create a barrier for an investment.

If you really want to be 'fair', you can simply calculate how many people in the team x number of months/years x monthly salary.
ex. 3 founders x 6 months x $10k, your valuation is $180k.
You see this works against you and gives you very little.

If you see that money is strategic money (means that there is more then just money offered, ex. advice, business development etc...), then you should give more to the investor.

If you choose the path of raising money, remember that founders shares are the last one to be paid, and initially they do not have a real value until they are triggered by investment, customers, etc...traction.

At the VC stage, when you raise round A, assume that a VC typically wants 20-35%. The number varies on a number of factors. But for simple calculations think of the above number (30%). Note, a VC takes their money out first (liquidation preference) and has a participation preference.

If you are attracting co-founders, then its a different story.
Lets say an engineers makes $120k/year, you can offer them a salary (or not) of $30k and $150k of shares at a certain valuation.

There are many many ways to answer this question. It all depends if you are chasing money (investment) or if you are not.

Happy to answer any questions.

On average, deals in Silicon Valley are getting valuations of $4M-$6M Pre-Money. In second-tier cities like NYC, Austin, Boston, there is about a 20% discount and the rest of the country about a 40%. Valuations at the seed round pre-revenue are based on 3 factors: how complete and season is the team, how close to Product/Market Fit is the product, and what kind of customer validation has been captured.

Beyond that it is just negotiations. Founders should raise money at the "Upper end of normal". It is very easy to get burned by closing a seed round at a high valuation and then getting highly diluted in the Series A because the valuation did not hold up and you have to do a down round.

Go for $6M and make sure your company has the milestones reached to sustain it.