A Unicorn is defined as a company with a $1b valuation while a Centaur is defined as a company with annual recurring revenue of $100m.

In recent years raising money for startups is becoming increasingly harder. For a successful startup traditional fund-raising stages were:

• Pre-seed: Typically FFF would give enough capital to create a prototype at this stage so you could explain the idea, and also test it to an extent. Maybe around £50k.

• Seed: At this stage, you would probably be looking at £500k at £2.5m-£3m valuation. The money would be used for building an MVP and a team. The round should last between 12 and 18 months and normally you would be raising the next round 9 months in.

• Series A: At this stage, you would probably raise around £3m at valuations of around £15m to £30m

Valuations

Let’s talk about what are the valuations and how they are calculated for a second.

For the sake of argument let’s assume me and my friend create a new company, we will create 90,000 shares and we would have 45,000 of them each. The company has no assets, no money, no nothing, so we probably don’t have any valuation yet, but we have a great idea. We go and tell our family, our friends, and also any fool who wants to listen to our idea and we convince them to give us £50,000 in exchange for a bunch of newly created shares. Let’s imagine we agree to sell to the initial investors 10,000. The new total amount of shares would be 100,000 and we know we can sell each share for £5 because we have done it. Our brand new company valuation would then be £0.5m.

Still with me?

Now for Seed money, we will once again create a new bunch of shares and sell them. We would create 20,000 new shares, selling them at £25 each. we would have now a total of 120,000 shares worth £3m in total.

Obviously, the folks from the pre-seed round are happy because their investment has gone up by 5x.

We need to keep repeating this for each round.

There isn’t a real way of calculating fair valuations. It’s a seller-buyer problem where to keep the previous investors happy, the seller tries to sell the shares as expensive as they can, while the buyer tries to push down the value as much as they can so the next rounds can yield a profit for them.

The process of coming up with a valuation at an early stage uses similar companies in the space, especially if they are publicly trading. When the companies are already generating revenues sometimes industry multipliers over revenue are used. The real problem is it’s all perception, you are buying at the perceived value of something that is really difficult to give a value to.

Over the years some bad players managed to get inflated valuations without substance underneath. This led to investors being way more cautious and sophisticated, and eventually in my opinion to shift the focus to more objective metrics, like revenue.

Revenue

Revenue, on the other hand, it’s more tangible, it’s harder to game and it answers the ultimate question of whether there’s a market for the product you are working on. Investors shifting towards revenue-generating investment thesis what they are doing is reducing their risk-taking. Some notable companies such as Facebook and WhatsApp did not focus on revenue generation until their user bases were very significant, and some could argue that was one of the keys to their success in the market. With investors forcing revenue focus from the beginning they could not have followed that approach. So with most investors shifting to focus on revenue, we could be missing out on incredible companies but I would argue incredible companies are made by incredible entrepreneurs and incredible entrepreneurs would be able to navigate the investment scene.

Also, it’s worth noting that for revenue-generating companies the valuations are often much easier. A multiplier of the revenue can be used to come up with a valuation, and often that multiplier is industry-based.

For instance, if we were trying to come up with a valuation for a social network we could use Meta revenue and market cap to calculate a good multiplier. At the time of writing Meta’s revenue was around $127b and their market cap is around $830b therefore the multiplier would be approximately 6.5. Let’s say your shiny new social network had a revenue of $100m, your valuations based on this approach would be $650m

As we have seen revenue and valuation are correlated and using a revenue-centric investment thesis the investors are trying to remove the bullshit from the picture.

So what can we do?

I always recommend people with ideas to write down a lean canvas. That helps them understand and articulate their business ideas. The canvas contains a few sections that help understand the revenue generation capacity, such as user segments, early adopters, and revenue streams. Formerly those sections were overlooked in the initial stages, but I would suggest you start most of your efforts focusing on them instead.

Revenue doesn’t mean profit. In the early stages, you can still spend more than you sell. As long as you have enough funds you could invest in acquiring users.

Learn your trade. Many investors would use ratios like funding to revenue to understand how well the company is performing. Make sure you know the ratios and metrics and tailor your business to optimize those that matter.