Funding milestones are significant events in the life cycle of a startup business which affect its valuation. Achieving funding milestones can improve the valuation placed on the business by investors and allows it to seek the additional funding necessary to reach the next milestone.
Our pre and post-money valuation calculator estimates the value placed on a startup business based on the amount of investment required and the percentage of equity you are prepared to sell in return for the investment. While numerically correct, the calculation does nothing to explain or justify to investors why such a valuation should be placed on the business.
How Funding Milestones Affect Valuation
Investors always seek to minimize risk. As funding milestones (such as obtaining a patent) are reached the risk associated with a business investment goes down and the potential reward to the investor goes up; the investor is prepared to pay more for the investment and places a higher valuation on the business. For this reason funding milestones are sometimes referred to as risk mitigating milestones.
As each funding milestone is reached the process repeats itself, the value of the business increases and the investors are prepared to provide additional funding at an appropriate level necessary to reach the next milestone.
Missing a major milestone will most likely result in a valuation below that set after the previous funding round, often referred to a ‘down round’, and cause the business significant problems in raising additional finance.
Funding Milestones Valuation Chart
It is often assumed that the value of a startup business increases in a straight-line as the business grows. In practice this is not correct, the value of the business will increase in a series of steps as funding milestones are met.
As each funding milestone is reached the valuation of the business takes a step increase as the risk associated with the business is reduced.
The funding plan for the business needs to take into account the timing of the milestones. For example in the above chart the valuation after reaching milestone 1 should support the funding needed to get to milestone 2 and so on.
Meaning of Milestone in Business
Funding milestones are significant events that the business can achieve in the future to indicate to investors that it is moving forward in accordance with its agreed business plan. The significance of each milestone is that it reduces the risk of the business and thereby improves the valuation placed on the investment by the investors.
Common Business Milestones
The types of funding milestones will vary from business to business; however, there are a number of common milestones which are likely to improve the valuation placed on the business by investors and lenders.
- Founder: Founder with a good reputation and track record within the industry in which the business operates.
- Management Team: A good management team with appropriate experience in all areas of the business.
- Non-Executive Directors: The recruitment of an experienced non-executive team capable of holding the board and management team to account.
- Intellectual Property: Intellectual property (IP) and in particular a solid patent protecting the business idea. In the absence of a patent a business idea in itself has minimal or no value.
- Proof of Concept: A proof of concept or POC shows investors that the idea is technically feasible and viable.
- Prototype: A working functional prototype demonstrates that the business has the know-how to develop the product. It enables the investor to visualize the product and allows testing with potential customers to be carried out to assess its desirability.
- Minimum Viable Product: A minimum viable product (MVP) sometimes referred to as a alpha release is a low cost saleable version of the product which has only basic features and functionality. Releasing the MVP into the market place allows the business and the investors to gauge customer reaction and engagement.
- Beta Testing: Beta testing is the final testing before the product is released commercially. A successful beta test including customer validation indicates to investors that the product is almost ready for full commercial production.
- Key Partnerships: Establishing key strategic partnerships with other businesses in areas such as production, distribution, marketing, and finance allows the business to grow and develop and improves its chances of success.
- Proof of Market: The proof of market verifies to the investor that there is a market for the product.
- Customer Traction: The business has a growing base of customers.
- Funding: The business has successfully negotiated a previous funding round such as grant or seed funding.
- Customer Sales: Sales to customers willing to provide references recommending the product to others or to significant (bellwether) customers.
- Revenue Growth:A growing sales revenue stream makes it easier for an investor to value the business.
The valuation placed on a startup business by investors will increase as the funding milestones are achieved and the associated risks decline.
It is important that the founders understand that their ability to fund the business is linked to achieving these significant milestones. Ideally discussions should take place with investors in order that the business can understand which milestones are important from a funding point of view.
At each milestone the business should seek to raise sufficient finance in order that it can comfortably reach the next milestone before running out of cash after taking into account its anticipated cash burn rate between milestones.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.