Week 4 ENT 640: Valuing Your Startup

Amis and Stevenson, in Winning Angels, write that valuing early stage deals is the next fundamental for the angel investor after sourcing and evaluating.  Valuing a startup is not easy as there are so many unknowns.  In Winning Angels, a variety of ways to value a deal are given and each angel investor will find the method in which he or she is the most comfortable.  The different methods fall into 5 categories: quick and easy, academic/investment banker, professional venture capitalist, compensated advisor, and value later.  Some of the methods are fast and not very complicated; for example, one of the quick and easy methods is a $5 million limit.  If the valuation is over $5 million, the angel investor will not invest.  Within the academic/investment banker method there is a multiplier method where a key number in the business plan is multiplied by an industry standard.  The professional venture capitalist method will use a combination of discounted cash flows, a multiplier and a return on investment to determine the valuation.  A compensated advisor may take a percentage of the equity while offering some type of support to the startup. The last method, pre-venture capitalist method (i.e., value later), has the angel investor contributing cash into the startup with the agreement that he or she will receive the same terms as those in the next VC round. Valuing a startup is complicated and the numbers can be daunting, yet each winning angel investor will find his or her way as he or she gains investing experience. (Amis and Stevenson)

These methods noted above are for the angel investor, but what can the entrepreneur do to determine the value of the startup before asking for an investment?

Asheesh Advani, CEO at Covestor, has the following tips to help entrepreneurs put a value on their company to help them raise money:

  1. You are what the market says you are. In other words, listen to the investors, if they are telling you that your startup is only worth a certain amount, then maybe that is what it is worth. Of course, you may know it is worth more because of the assets you have or the sweat equity you have into it.  Nonetheless, you still may not be able to raise money if your valuation is too high and thus you will need to accept what the market says.  This may not be the case when family or friends invest in you.  This, however, could lead the company to be overvalued or undervalued–more commonly it is overvalued in this case. (Advani)
  2. You can also tell the market what you are worth. This tip seems to contradict the first one, but you can tell the market how to value your company.  Many startups do not have any financial history for investors to look at and so you need to provide them comparables and financial forecasts. Look at the worth of comparable companies in your industry and geographical area.  Advani suggests using either of these sites: http://www.bizbuysell.com/  or http://www.bizquest.com/.  If you are in a high tech or high growth industry, he suggests using accountants and lawyer as advisors.  Although it is difficult to do financial forecasting for a startup, you need to do this to defend the value of your startup.  Depending upon the industry, the financial projections may vary. (Advani)
  3. You’re not really worth anything until you’re profitable. Therefore, valuation is a challenge for a startup.  Because there typically are no immediate profits, the startup needs to focus on the future.   The first step is to determine how many years it will take to be profitable.  The value of the startup will be higher if the startup gets to profitability sooner.  The second step is to look at comparable companies and their value when they reached profitability.  The startup could be worth some fraction of that number taking into consideration the management team, time frame to exit and the possibility for success. (Advani)

Carlos Eduardo Espinal, a partner at http://seedcamp.com and former venture capitalist, has these 4 suggestions to get investors to pay more for your company:

  1. Pick a hot sector.
  2. Have an experienced management team. Serial entrepreneurs can command a better valuation. This gives investors faith that you can execute.
  3. Have a functioning product.
  4. Get customers to tell the investor that you have value.

Choosing a method to value a company may be cut and dry for the experienced angel investor.  Those new to investing may want to find an experienced mentor to help them at their beginning stages of valuing startups. Entrepreneurs should never forget that they won’t be able to get investors if they don’t take the time to value their startup and provide the supporting data.

Resources:

Advani, Asheesh. “How to Value Your Startup.” Entrepreneur. Entrepreneur Media, 06 Sept. 2004. Web. 01 June 2017. <https://www.entrepreneur.com/article/72384>.

Espinal, Carlos Eduardo. “How Does an Early-stage Investor Value a Startup?”Seedcamp. Seedcamp, n.d. Web. 01 June 2017. <http://seedcamp.com/resources/how-does-an-early-stage-investor-value-a-startup/>.

Amis, David, and Howard H. Stevenson. Winning Angels: The Seven Fundamentals of Early-stage Investing. London: Financial Times Prentice Hall, 2001. Print.

6 thoughts on “Week 4 ENT 640: Valuing Your Startup

  1. Great Post!
    I like the 3 points you talked about: 1) You are what the market says you are 2) You can tell them what you are worth and 3) You are not worth anything until you are profitable! Wait – what? Entrepreneurship is great but it’s not easy! We have to know who we are and what our business represents before we seek funding from angel investors. They can tell us how much we are worth, but we have to know for sure. And, I agree with #3, people “assume” our business is not worth anything until we are making money. But, that’s not 100% true, our ideas, love and investment is worth more than money.

    Great job,
    Christina

  2. Cece,

    After reading your article it seems that you have to have an up and running company and product before they can possibly determine the value of the company. Also that they value of the startup will be higher if it generates a profit sooner, but how can it be determined when a profit will be made? It does seem very complicated to figure out what the value of a company would be before you know what the value would be. Great article!

    Thanks,
    Mackensie

  3. Cece,
    Great outline of points and post in general! Regarding the valuation of a company, I think it’s also important to note that the value of a company comes from the price people who invest are willing to pay – not the outside world who won’t invest. I hear a lot of stories about analysts saying that a certain stock is “overvalued” and that it just isn’t worth as much as it is trading for. But if that were the case, the people who invested in the stock wouldn’t have done so in the first place. So it’s hard to see how being overvalued is even possible as long as people are willing to invest.
    Austin

  4. Valuing is the place where your perception meets reality with real investors. You have shown that what you think because of what you invested may not always what the real market value is. I like the suggestion that you do not have real worth until you have made real profit. I often talk to people with great ideas, but I ask them who is going to buy it and it is marketable here in this geographic location. I ask them to think about what could cause the business to fail instead of succeed. Their great idea could sink their finances and their dreams because it can not be profitable in this small town.

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