Key Metrics in Valuing Pre-Seed Startups

Do you know how startups secure the funding needed to succeed? It all begins with the Seed Stage, where founders utilize personal resources, contributions from friends and family, or early-stage investors to build a prototype or validate their concept.

In the second quarter of 2023, SAFEs (Simple Agreements for Future Equity) emerged as the predominant method for pre-seed investments, constituting 80% of the invested capital.

The IPO represents a significant milestone as the startup goes public, offering shares on the stock exchange, providing an exit for early investors, and raising capital for future growth. While the path may vary, this is the typical startup funding outline.

What is a Pre-Seed Startup?

It refers to a very early-stage company in the initial development phase before seeking significant external funding. At this stage, the startup is often in the concept or idea stage, and the founders use their resources or funds from friends and family to get the business off the ground.

The term “pre-seed” implies that the startup is seeking funding to help it progress beyond the ideation phase but has not yet reached the formal seed funding stage, where more substantial investments from external investors, such as venture capitalists, typically come into play. Entrepreneurs use pre-seed funding to conduct market research, develop products, and build prototypes to attract additional investment.

How do you assess key performance indicators (KPIs) and non-financial metrics for a pre-seed startup?

Identifying key performance indicators (KPIs) for pre-seed startups is crucial for assessing their progress and potential for success. While financial projections are essential, other non-financial metrics also play an important role in startup valuation. Let’s explore both aspects:

Key Performance Indicators (KPIs) for Pre-Seed Startups:

Customer Acquisition Cost (CAC):

This metric helps in understanding how much it costs to acquire a customer. Pre-seed startups must ensure that customer acquisition is cost-effective.

Customer Acquisition Cost (CAC) = Number of New Customers Acquired / Total Marketing and Sales Expenses.

For example, if a startup spent $10,000 on marketing and sales monthly and acquired 100 new customers, the CAC would be $100.

Customer Lifetime Value (CLV):

CLV represents the total earnings a business can anticipate from a single customer over the entire relationship. A high CLV compared to CAC indicates a healthier business model. CLV= Average Revenue Per User(ARPU) / ChurnRate Alternatively,

CLV= Average Purchase Value×Purchase Frequency / ChurnRate​

For instance, if the average revenue per user is $50, the churn rate is 10%, and the average purchase value is $25 with a purchase frequency of 2 times monthly, the CLV would be $250.

Monthly Active Users (MAU) or Weekly Active Users (WAU):

Regular tracking of active users is vital for pre-seed startups, especially those offering digital products or services.

Churn Rate:

Churn is the rate at which customers stop using a product or service. High churn can be harmful to a business, and understanding and reducing it are critical for sustained growth.ChurnRate = Total Number of Customers at the Start of the Period / Number of Customers Lost during Period ×100.

If a startup began the month with 50 customers and lost five of them by the end of the month, the attrition rate calculation is as follows:

5 / 50 × 100 = 10%

Conversion Rate:

The conversion rate indicates the fraction of users who complete a targeted action, such as purchasing. Enhancing conversion rates is crucial for optimizing the sales funnel. ConversionRate = Number of Visitors / Number of Conversions ×100.

For example, if a website has 1,000 visitors and 50 of them purchase from it, the conversion rate would be:

50 / 1000 × 100 = 5%

User Engagement:

Analyzing user interactions, time spent on the platform, and feature usage can reveal insights into how well the product resonates with users.

Metrics Beyond Financial Projections in Startup Valuation

Market validation requires demonstrating demand and confirming product-market fit through beta testing, pilot programs, or early customer testimonials.

Evaluating the skills of the founding team is crucial, and a robust IP portfolio or strategic partnerships can additionally boost the startup’s valuation.

What is the importance of market traction and customer validation?

When valuing pre-seed startups, market traction (The ability for an idea to become popular) and customer validation are important to see how well a startup is gaining attention and progressing in the market.

Here’s why these factors matter:

• Market traction and customer validation prove real demand for a startup’s offering.
• Mitigates known risk for investors, which is crucial at the pre-seed stage.
• Higher market traction enhances startup valuation during fundraising or acquisition talks.
• Customer feedback aids in refining and improving the product or service.
• Demonstrated market traction attracts investor interest, signaling growth potential and increasing funding chances.

How do you build a holistic view of a pre-seed potential through metrics?

Metrics provide a comprehensive understanding of the pre-seed startup’s market opportunity, product-market fit, financial viability, traction, social impact, competitiveness, customer satisfaction, and scalability, contributing to a holistic view of its potential for success. Such as,

• Market Opportunity: TAM and SAM metrics quantify the revenue potential within the target market segment, considering the startup’s capabilities and resources.
• Product/Market Fit: User engagement, feedback, and retention rates indicate how well the startup’s product meets market needs and resonates with users.
• Customer Acquisition: CAC, CLV, and conversion rates reveal the effectiveness and scalability of the startup’s customer acquisition strategies.
• Financial Metrics: Burn rate and gross margin assess the startup’s economic health and sustainability, providing insights into its runway and profitability.
• Market Traction: KPIs and partnerships demonstrate the startup’s momentum and growth trajectory, indicating market acceptance and demand for its offering.
• Social Impact and Sustainability: Allocating profits for social impact and eco-friendly practices enhance the startup’s brand reputation and appeal to socially conscious consumers.
• Competitive Analysis: Identifying key competitors and highlighting unique value propositions help position the startup in the market and differentiate it from competitors.
• Customer Satisfaction and Brand Perception: NPS and brand recognition metrics gauge customer satisfaction and brand reputation, influencing customer loyalty and word-of-mouth referrals.
• Scalability: Expansion plans and strategies for entering new markets demonstrate the startup’s potential for growth and scalability over time.

Get a 409a valuation for your Pre-Seed Startup from Eqvista!

It is now evident that securing pre-seed funding for your startup can pose challenges. Still, it’s important to have a compelling product or service, a good business model, a credible team, and a well-established network to increase your chances. Additionally, obtaining a 409A valuation is vital for determining the fair market value of your startup’s stock. Eqvista offers accurate 409A valuations for companies globally. Contact us to know more!