How do you value a start up? This is the golden question and one I get asked on every investor's pitch.
The common answers are: we have compared our valuations to similar businesses at this stage and our valuation is based on that. XYZ accountants have calculated our valuation based on a cash flow discounting model of xyz. Cash flow discounting is a very complex procedure of valuing a company and is recognised by most professionals, if done correctly.
However we believe an investor is really testing you with this question. It should be based on the return, you and your team, what you need to deliver on your business proposal and more importantly what a savvy investor is prepared to pay for equity in your business. No valuation model will ever do that for you.
Our view is that your valuation should be centred around these questions:
By investing xyz you will get xyz back in this time.
The market is worth xyz and we will acquire xyz through investing in xyz.
My team is worth xyz and have the experience and skill to deliver and execute the business plan.
The valuation needs to take into account risk and reward, then ask yourself, Would I buy this company at that valuation right now? Remember it is a pre money valuation so would you buy the company if it had the money in the bank ready to invest in the proposed plan.
Also does your company qualify for SEIS OR EIS? An investor cannot own more than 30% to get these tax benefits. This could have some sway on the investment decision and valuation as it increases the attractiveness of the proposition and can result in investors perceiving the opportunity as having less risk attached .
So if you are asking for a million on a valuation of £3 million be prepared to explain the following;
What’s the investment for and will that level of investment secure the success of the business?
Investing in marketing is like investing in thin air unless you have a proven tested formula.
Investors like to see investment in IP and people so you are securing your future.
It's better for you to have a 1000 solid consumers utilising your product or service rather than 100,000 visitors that have looked and gone. Michael Gerber says business is simple, finance, sales and product. Invest in all three not just MARKETING.
What is the risk to the investor and how are you going to protect them?
How is the investor going to get their money out? And, what is the return?
A VC on success wants a ten times return so your business plan will have to show an exit of £30 million in 3 - 5 years on a £3 Million valuation. Don't just pick a figure out of thin air, stress test your formulas.
My friend and mentor Bob Chase says the one thing you can guarantee about forecasts is that they will be wrong as soon as you have written them. No one has a crystal ball, but to be the A team you need to have a great plan and the ability to implement it. Remember, the idea itself is only part of what an investor is looking for, the skills and expertise to carry out that idea successfully form a major part of any savvy investors decision.
Your exit valuation will be based on a similar business that has exited before. I would do this with at least 3 businesses so you can provide evidence if asked. Find out what they sold for and what their profits were for that year. Divide the sale price by the profits and you then have a multiplier. Then take into account your assets and future profits to devise your exit valuation.
It’s a bit like a surveyor on a house - they will get three previous sale prices of similar houses in your area and then take into account all the improvements you have made and the position your house is in.
The end result for any valuation is; Can you sell this to an investor? Don't get hung up on keeping all the shares, after all 100% of nothing is nothing, but 10% of 100 million is a lot! Be open with your investors, don't get set in stone, negotiate and close the deal.
Please remember I am not an expert valuer or accountant this is just my opinion and is based on my experience if you have the funds get professional advice.
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