Pricing A Follow-On Venture Investment

Today on MBA Mondays, I am going to walk you through some math that our team does when looking at a venture investment in a company that is starting to scale its business.

Let's assume we have a portfolio company. I will call it It is a marketplace for fitness experiences. We invested in it last year as it was getting ready to launch. A year later the business is scaling nicely and needs more expansion capital. The founders don't really want to go out and do a fundraising process. So they have asked the existing investors to make them an offer for an internal round. They believe they need $3mm of expansion capital to get them to cash flow breakeven.

So now the VC firm (us) needs to figure out what is a fair price. So we pull out Google Docs and run some numbers. For those who didn't click on the link and see the spreadsheet, here are the numbers:

– is on track to generate $10mm in gross transactions in 2011

– they operate on an all-in "take rate" of 9% so their net revenue in 2011 will be $900k

– they will have operating costs in 2011 of $1.5mm and they will lose $600k this year

– they plan to triple gross transactions in 2012 to $30mm and grow to $150mm in gross transactions by 2014

– they plan to do this while ramping operating costs to $3mm in 2012 and to $7mm in 2014

We lay all of those number out in a spreadsheet and then look for some multiples to apply to them to get to a sense of value. The two multiples I like to use for marketplace businesses are enterprise value/gross marketplace transactions and enterprise value/EBITDA. And the multiples I like to use are 1x gross marketplace transactions and 20x EBTIDA. These are for internet marketplaces that are growing fast and are category leaders.

I've observed these multiples over a long time, going back to eBay and Mercado Libre a decade or more ago. We keep a spreadsheet of all Internet marketplace financing transactions in our portfolio and also include transactions we are very familiar with. That spreadsheet validates these multiples again and again.

When using multiples, one question that comes up is "do we apply these multiples to the current year results (which are almost in the bag), the current run rate (current month X 12), or next year's forecast. My answer to this quesion is "yes." I like to apply these multiples to all three and then triangulate from there. The reason being that when markets are frothy, investors will often give a company valuation credit for the next year's forecast (meaning a forward multiple). But when markets are tough, the multiple will be on the last twelve months (meaning a trailing multiple). You don't know what kind of market you will find yourself in so you should look at the multiples in a number of ways and triangulate to get to a comfort zone.

We did this in our spreadsheet (just for the current year and the next year) for our two multiples (1xGross and 20xEBITDA) and we got to a range of valuations for 2011, 2012, 2013, and 2014. They are:

2011: $10mm to $30mm (midpoint $20mm)

2012: $30mm to $75mm(midpoint $52.5mm)

2013: $35mm to $150mm (midpoint $92.5mm)

2014: $130mm to $150mm (midpoint $140mm)

So that's how we think about valuation. The spreadsheet says that if the Company hits plan, it will grow from a valuation of $20mm now to a valuation of $140mm in three years. And if we invest at that valuation of $20mm, we stand to make 7x on our investment in three years if the Company hits plan. If we pay at the top of the valuation range right now ($30mm) and get out at the top of the valuation range in 2014 ($150mm), we stand to make 5x.

I believe 5x to 7x is a good return objective on a follow-on investment in a venture stage company that is scaling nicely. We look to make 10x on our initial investment but cut our return objectives back as the risk comes out of the investment. There is still a tremendous amount of risk in a follow-on investment of this stage (mostly related to executing, hitting plan, etc) and a big multiple is still appropriate.

So that's pretty much all that is involved. We talk this over with our entire team and decide what to offer and what our walk away price is. Based on this analysis, I believe our offer would be around $25mm pre-money, $28mm post-money. We might go up a couple million to get the round done but I think $30mm post-money would be as high as we would go. At that point, we would encourage the founders to go out and find new investors to price and lead the round.

#MBA Mondays

Comments (Archived):

  1. andrewparker

    Great post Fred.  The times I learned the most on the job at USV was doing analyses like this, and I love to see you sharing this with the world.One thing to add:The post-money valuation on the *prior* round is perhaps the most important data point when it comes to doing an internal follow-on financing.  It shouldn’t be… in an ideal world a company would always raise at a valuation that reflects its current value, but many times that’s not the case. Your analysis gets to a fair price for right now.  But if the Post on the last round was 200% of that new price, I think this situation would be managed very differently.  You’d also have a very different situation on your hands if the prior Post is 10% of this new price.

    1. Danny Moon

      If a company is not currently generating revenues do you use the same calculations?  Do you take their forward projecting numbers and apply the same multiples or is there a discount applied since the business model has not yet been proven? Or is it better for fast growth companies without scalable revenues in place to test the market and look for outside investors to set valuation?

      1. Mark Essel

        I like the sound of your second offered question/alternative. Without revenues driving the valuation, it makes sense to allow the capital market to set a fair price.

      2. fredwilson

        that’s what we would do, but we’d want a higher return in that situation

    2. fredwilson

      Great point. I left out all mention of the prior round on purpose. I believe that companies should be financed at their current fair value whenever possible. Its true that isn’t always possible and when that is the case its a problem for everyone

      1. ShanaC

        why does that happen though

        1. fredwilson

          for the reasons andrew cited. if the prior round was priced too high, then you end up putting more money in at the last round price, which can still be too high

          1. ShanaC

            I think I want to know why the overpricing and too much money gets put in the first place (creating follow on problems) Sorry!

          2. Jordan Elpern-Waxman

            Generally some sort of misjudgment by the investors: assumptions about market growth, company prospects, technology adoption, etc. that don’t pan out. That’s not an indictment of the investors, just a reality of the risks inherent in VC. Aka the things that make VC interesting!

  2. andrewparker

    Oh, and I’ll bet you a dollar that, the marketplace for fitness experiences, exists by year end

    1. RacerRick should be the marketplace to buy/sell handmade fitness equipment.

    2. Joe Yevoli

      ha, +1.. 100%

    3. fredwilson

      Get the URL now. You will have the pole position on the financing

  3. Pascal-Emmanuel Gobry

    Amazing transparency Fred. I don’t think anyone has gone so deep in detailing how VCs price and decide investments, especially one as hush-hush as inside rounds.

    1. VC Experts

      Checkout the Private Company Analysis Tool and the Valuation & Deal TermDatabase at More andmore industry professionals are utilizing these tools to increase efficiencyand decrease the time spent in using desktop spreadsheets.

    2. fredwilson

      I am certain this post will be used against us in a price negotiation. I am equally certain that we will have gotten to work with that entrepreneur because of posts like this one

    3. sventured

      Agreed 100%. Thank you, Fred.

  4. William Mougayar

    Great insights, and thanks for sharing. We need more of what goes inside a VC’s head and thinking like that. That spreadsheet and process are so valuable. 

  5. Adam Steiner

    Thanks for the post Fred.I assume the other (non-USV) transactions in your spreadsheet are either numerous or significant enough to take care of the self-fulfilling prophetic nature inherent in a list of USV transactions being used to validate your multiple preferences.

    1. fredwilson

      yes, that is why they are therebut we only include transactions where we know for sure what happened

      1. Adam Steiner

        Gotchya.(for some reason I missed your reply in my Disqus notifications)

  6. Nate Quigley

    You’ve built an incredible amount of trust with posts like these. It screams “I’m a fair dealer, do business with me”. Really appreciate what you and a few others are doing to increase the efficiency of the entrepreneur-VC market. Awesome.Imagining you have similar rules of thumb for other business models you invest in. Hoping this is the start of a new Monday series…

    1. Matt A. Myers

      I hope so too, but I think Fred’s a bit of a tease.. he can’t give away everything or you won’t  need to come back. 😛

    2. fredwilson

      well i guess i’ll take a shot at SAAS next week although we don’t have a lot of them in our portfolio

      1. William Mougayar

        In that case, run your draft shot by a couple of non-USV Co’s that have SaaS if you need more data points.

  7. Tim

    shouldn’t 2013’s low valuation be $35mm (instead of $25)? 

    1. fredwilson

      yes, great proofreading. i will fix asap. thanks!!

    2. Mark Essel

      Thanks Tim, thought I missed something in my skim. Wondered why 2013 had a lower low end than 2012, assumed typo but the confirmation helps impart clarity.

  8. Michal Illich

    And what happens when they don’t hit the plan? Is it defined in the contract?And how are you verifying whether the plan is reasonable?

    1. Matt A. Myers

      Solid team, trust, past projections, current traction and growth?

    2. fredwilson

      we don’t put anything in the contract penalizing a team for not meeting planbut there is always the next round to address things

  9. PhilipSugar

    I love when people give numbers like these.  Yes people can argue what about this or that.  But it is so refreshing to see somebody at least put out a number.I really try to do it as a software company.  “is it bigger than a breadbox” “are we in the same ballpark?’  I’ve had people profusely thank me, because if you have uncertainty it causes anxiety.I think, that the days of: How much does it cost? How much do you have to spend?  Are going away, people want price certainty and the internet is giving it to them.

    1. fredwilson

      these are the numbers we use so i figure i might as well put them out thereif we start using different numbers, i’ll put them out there too!

  10. Brad

    You really are an open book….Where do you come up with the multiple of 20x?Why in 2012 do you not use a current year EBITDA 20x?Thanks in advance.

    1. fredwilson

      i believe i used both 20x current and 20x forward

  11. fhundt

    Can you explain “pre-money” and “post-money?” Thanks for sharing this approach.

    1. Graham Siener

      The short answer to the question is that they differ in timing of valuation. Both pre-money and post-money are valuation measures of companies. Pre-money refers to a company’s value before it receives outside financing or the latest round of financing, while post-money refers to its value after it gets outside funds or its latest capital injection. Pre-money valuation refers to the value of a company not including external funding or the latest round of funding. Post-money valuation, then, includes outside financing or the latest injection.More at:…

    2. Aaron Klein

      Just as a rule of thumb for usefulness, here’s one way to think about it.Post-money is what your company is worth after the investment. Visualize yourself after the investment is made. You’ve got $3MM in cash in the bank, and your company is worth $28MM. Does that seem fair to you? If so, sign that term sheet.Pre-money is what the new investor is valuing all of your existing equity at. So let’s say that your last round was at a $5MM valuation. With a $25MM pre, the new investor is saying that your founders and existing investors have made 5x on their money so far.(And I know few entrepreneurs to whom that wouldn’t seem fair, so they would sign that term sheet.)

    3. fredwilson

      post-money is equal to pre-money plus the amount raisedso in the example aboutpre is $25mmamount raised is $3mmpost is $28mm

  12. Aaron Klein

    Fred, I’d love to see a post on your different benchmark multiples for different kinds of companies.It’s always difficult for entrepreneurs to think through what those multiples should look like for their company.I know the multiples tend to change, but that gives you even more of an opportunity to explain why you see this as a frothy market.

    1. fredwilson

      i should do that. i know that marketplaces trade at or around 1x gross transactions. i know that SAAS businesses trade in the band of 3x to 6x revenues (sometimes a bit higher). it would be great to lay all this out

      1. Aaron Klein

        Awesome.My last startup was SaaS back in 2006. (Could not for the life of me convince VCs that small businesses were going to buy software over the internet.) Our rule of thumb was 2.5 to 3x revenue.So that shows you how markets have changed a bit… 🙂

        1. fredwilson

          yes, valuations have gone up. but they could be headed down. markets go up and they go down.

          1. Carlos Tobin

            For your viewing pleasure. According to the Pepperdine Private Capital Markets Survey Report (Summer 2011), the average tech companies, that fit this example, had revenue multiples of 2.4. Their EBIDTA multiple was 11. Revenue multiple = 2.4EBIDTA $5M+ = 11 Cost of expansion capital = 20%-30% per year.  

  13. Mike

    Fred and others, here is an amazing and transparent post by Rand at SEOMoz on his recent follow up round of fundraising for SEOMoz. His transparency and openness is like you Fred.I hope you guys enjoy and learn some things.…Mike

    1. fredwilson

      that was an amazing post. i read it a while back. incredible detail and transparency

      1. Mike

        Fred, this is a new post – he just posted it today.

          1. fredwilson

            yeah, that was the one i was thinking of

        1. fredwilson

          i just went and read it. he got screwed over. so uncool.

          1. Mike

            Yeah, he got screwed. You have integrity Fred and that’s why you are well respected and admired. Thanks!

    2. Pete Griffiths

      Thanks for the link, Mike.

  14. baba12

    “We keep a spreadsheet of all Internet marketplace financing transactions in our portfolio and also include transactions we are very familiar with.”Would Mr.Wilson elaborate on this and possibly share this spreadsheet without naming the companies, possibly edumacate us folks.

    1. fredwilson

      that’s something we are not going to share at this time. it includes too much confidential information

  15. Nav Dewan

    Fred, I’m wondering about the EBITDA of 20X in a time when the market is down and multiple companies are failing to deliver.To re-phrase, ‘When’ would you consider lowering the EBITDA multiple?Thanks

    1. fredwilson

      well MELI is still trading at 29x trailing EBITDA, so not yet

  16. KenHoinsky

    Love these kinds of posts, Fred. Keep ’em coming.

  17. Pete Griffiths

    Fred – how do you value rounds for consumer internet companies like facebook, twitter or tumblr in their early stages that are focused on building large networks of engaged users but may not have any revenues or even specific plans for monetization. I absolutely believe that such companies will have huge upside, it is certainly possible to measure adoption, retention, engagement etc but how on earth do you price them?  Do you have rules of thumb you can share with us?

    1. fredwilson

      yes, since we focus on “large networks of engaged users” we use a multiple of “engaged users” which is daily actives, weekly actives, and monthly actives.

      1. Guest

        How do multiples look for DAU/MAU/WAU? I guess most companies would not be valued on revenue/EBITDA early in the cycle.

      2. Pete Griffiths

        And is this an algorithm that you have found to be reliable? 

  18. Jason Dunn

    just tuning into your blog. Very much enjoy. Thank you for sharing!

  19. Darren Herman

    You’ve got this magic spreadsheet in the office of comps and 1st party data of your portfolio.  Is there an organization that aggregates all of those data points across investors and makes them available at a subscription price?  I’m sure many investors of both public and private markets would enjoy having access to these (at a price of course).

      1. Darren Herman

        Thanks Michael.  Will check out.

  20. Eric

    Fred,How do you price for a follow-on round for a non rev company like say twitter in its second year? (twitter as example only…)

    1. fredwilson

      honestly, you put your finger in the air and guess. i really cannot give a good analytical framework for that. fortunately we got Bijan at Spark to do that round so we did not have to do an internal round.

      1. Steven Kane


  21. Julian Tol

    Thanks Fred – timely info for our own Series B raise, providing this methodology works for Asia. 🙂

  22. Carl J. Mistlebauer

    I am having trouble converting “Gross Transactions” and “Net Revenue” into concepts that I understand!

    1. fredwilson

      lets use ebay because most people understand their business. gross transactions is every sale that happens on ebay. net revenue is the combination of listing fees, transaction fees, and other fees they charge sellers. for most marketplaces net revenue is between 5% and 15% of gross transactions. that is called the “take rate”

      1. Carl J. Mistlebauer

        Thanks Fred, I knew that the term “transactions” had to refer to something other than the stereotypical “gross sales” Now I am starting to grasp how internect/tech firms are valued.  This has been a sticking point during my current discussion with investors as I keep telling them that the reality is we are creating not only a niche product market (old economy) but the real value is in the technology used to develop a niche community, which in turn can become an income stream to other products in our niche.

  23. JZedlitz

    That was concise, pragmatic, and clearly articulated. I am going to use this framework tomorrow. Thank you.

  24. Robert Hacker

    Having the benefit of the comments, I still do not see whether anyone asked if the valuation would have been the same if you were not an existing investor doing a follow-on round. In other words, if the company had the same metrics but was not an existing investment would the methodology and valuation result have been the same (assuming no competing investors)?

    1. fredwilson

      the whole point of this exercise is to treat the situation as if we were a new investor

  25. Steven Kane

    thanks fred. stuff like this makes,

  26. Carlos Tobin

    According to the Pepperdine Private Capital Markets Survey Report (Summer 2011), the average tech companies, that fit this example, had revenue multiples of 2.4. Their EBIDTA multiple was 11. Revenue multiple = 2.4EBIDTA $5M+ = 11 

  27. Camilo Telles

    Fred,Really useful post. When do you say that expect 10x return, is it in what span of time?RegardsCamilo 

    1. fredwilson

      however long it takes.i mean that.

      1. Camilo Telles

        Fred,It doesn´t matter if it will return in one year or seven years? You don´t think about IRR?ThanksCamilo

        1. fredwilson

          a good VC fund will deliver a 25-35% IRRand to do that you have to be patient

          1. Erich von Hauske

            I’ve met some entrepreneurs who don’t understand the kind of pressure a VC has when investing in us, and can’t understand why they need/expect a 10x return.How many Home Runs (100x), Hits(10x), Base on Balls (2x) and Strike Outs (0x) do you need to have that performance in 5-7 years investments?I understand is a lot more complex than just putting some numbers there, but having some ballpark numbers would help convince some eskeptics 🙂

          2. fredwilson

            1/3 hits1/3 walks1/3 strikeoutsif you get a home run, then you are top decileif not, but you hit for this average, you are top quartile

          3. Erich von Hauske

            It is 2x a good threshold to divide a walk from a strikeout??? I have no idea at all

  28. Jimmy Ak

    Great article…I also use Enterprise Value/EBITDA and DCFA…

  29. Bill

    We are a neighborhood e-marketplace for 50+% Off Deals. We’re available in 22,000 cities/towns in the US and this post was tremendously useful as we look at bringing in a 2nd round. Our first was self-funded and this helps us look at how a VC might set a valuation range.Much appreciated and I haven’t left your blog for over 24 hours…there’s so much value here it’s amazing!Thank you