What this means for your Series A deal is that, to a large extent, the value of your company is going to be reverse-engineered from the cap table. Here is how this works:
1. You and your investors agree you need $X ($3M, for example)
2. The investors want to own a certain percentage post-financing (I%) (2 x 20% = 40%, for example if two VCs are syndicating the deal)
3. The post-money valuation is now $X/I% or $3M/40% = $7.5M
4. You negotiate the size of the option pool (P%) (25%, for example)
5. Your true pre-money valuation (what the founders’ stake is worth) is $X*[(1-I%-P%)/I%] or $2,625,000.
There are two things to notice about this process. First, at no point did it require justifying the value of the startup. Second, the margin for negotiation is somewhat limited as (a) the option pool size should be budget-driven and (b) most investors, rightly or wrongly, are pretty set on the percentage ownership they require.
via xconomy.com