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By Nathan Rose, Assemble Advisory
The valuation, combined with the amount you have decided to raise, will determine the slice of equity new investors get in your company. This valuation needs to be fair to new investors coming on board, as well as to existing investors.
Startup valuation is not an easy subject to get good information on. You will no doubt have frequently heard statements such as “there are too many factors to consider,” which of course is no help at all. Investors and company founders are confronted with the need to arrive at a valuation, despite the difficulties.
It’s true that there’s no perfect mathematical formula to arriving at a ‘right’ startup valuation. You may have heard “the valuation of a startup is set as whatever an investor is willing to pay for it”, and this is true – but even if arriving at a startup valuation comes through a negotiation, you need to have some starting point to begin your negotiating position from. There are three main pieces of analysis you can do.
If this is the first time your company has raised capital, then you cannot use this method. But, if you have raised money before, investors will look closely at your past valuation rounds in order to anchor their expectations for this time. Let’s say that you raised money from angel investors 12 months ago, at a valuation of $800,000, and that your revenues and staff numbers have doubled since then. The new investors can use the $800,000 value that past investors used, then make an upward adjustment to account for the additional progress you have made.
Equity crowdfunding has now been going for long enough that a good startup valuation data set has now been built, based on valuations achieved by previous successful offers. Before equity crowdfunding platforms rose to prominence, it was almost impossible to get such reliable data.
Scan for past successful fundraisers that are similar to your own in terms of:
The more progress you can show towards building a consistent, reliable cash-flow-generating machine, the better. If all you have is an idea, then it’s worth virtually nothing. If you have gone out and got patents, or initial users, or conducted market research, then that’s a good start. If you have actual paying customers, and track record, then that’s best of all. The degree of past execution you can point to will play a big part in your startup valuation.
To find these past offers, you can look through the database of the platform you are looking at using, other major platforms in your country, and aggregation websites which are starting to appear such as HelpTheCrowd, which aggregate offers from many different platforms together.
Investors, particularly in startups, are trying to ascertain the probability of the venture succeeding, and the payoff that could be possible if it does. Putting together a well-thought-out financial model will be a powerful negotiating tool — you can show potential investors what your business will look like under a range of assumptions. For example:
A well-constructed financial model can answer these questions in seconds. You and your investors can decide together what seems realistic.
I need to mention the Discounted Cash Flow method as well, because a lot of startups have heard of it and wonder whether they should do one.
In brief, the discounted cash flow method uses a company’s projected cash flows from the financial model, and an assumed discount rate (which is basically a measure of riskiness) to assign a theoretical valuation.
Discounted cash flow is indeed a method used for valuing companies, but it is only useful when they are at a later stage. If your company is very mature (think: listed on the stock exchange, or at a level where it could be), then you might be able to start coming up with accurate long-term projections.
For startups and growing companies, though, it is extremely problematic. The inputs are too uncertain. The best you can probably do is forecast what your company might look like in 12 or 24 months, whereas a discounted cash flow requires you to have at least some idea of what the next 5 to 10 years might look like. If you currently have 500 customers, and only 12 months of operations behind you, it is completely futile to try to predict your position in 5 years from now. If you assume you’ll have 10,000 customers, you might call your value $100,000 now. If you assume you’ll have 1,000,000 customers, you might call your value $5 million now. So, which is it? It’s impossible to say; therefore, the exercise is virtually pointless.
Investors will have the opportunity to challenge the valuation you arrive at, and when someone asks you how you arrived at your valuation, you want to be able to point to some robust thinking that went into it.
Given the stakes, it may make sense to get professional independent advice, so you neither over-value the company (leading to a failed funding round) or under-value it (leading to giving up a larger slice of equity to new investors than you need to).
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