One of the most common questions we get asked at Angels Den is how do I value my business? Valuing your startup is a tricky concern. The reason this question comes up so often is because there is no simple answer. The valuation dictates how much equity you need to sell in order to get the funding you require. However, there is a fine line between holding onto a large share of your business and setting the valuation so high that it puts off all potential investors.
The bottom line is that your business is worth as much as an investor thinks it’s worth. But in order for you to come up with a valuation in the first place, you need to consider the following five things.
Revenue
The hard truth is that until your business is post-revenue, it isn’t worth that much. Unless you’ve proven your revenue model and that there is the market demand then the investment is little more than a punt. This means that if an investor does want to finance your pre-revenue startup, they’ll tend to want a decent chunk of equity.
The best thing to do is actually to follow the lean startup model or bootstrap to MVP until you can prove your revenue model, at which point you can raise a lot more capital at a much higher valuation. We read with amazement that one of our American business angels values all pre-revenue companies at $100K, if he likes the idea he would give it $50K for 50%. Hmm?
Team
A good investment opportunity is not just about the idea but the founders’ ability to execute that idea. If you’re a serial entrepreneur or have Richard Branson on your management team, then the investor will be more confident that you will deliver on your promises. This means that the team’s previous experience will have a direct bearing on the value of your business. To have such people investing their time and energy attracts a premium.
Comparables
Now comes the task of coming up with some real numbers. The best place to start is seeing what companies in your sector have been valued at. If you are operating in a growth sector, then you will see much higher valuations than if you’re in a depressed sector.
For example, at our Tech Club it us unusual to see a startup valued for LESS than £500,000. The chances are you won’t be worth as much as a more developed competitor, but if your revenue and performance are similar, then you can use that competitor to justify your own valuation.
Potential
Although valuing a startup is a bit of an art, there is also some science involved. Investors like to see that assuming your calculations are correct there is the potential for high-growth and a good return on their investment. This can be done by taking your predicted EBITDA for the second year in which you make a profit and multiplying it x2. So let’s say you expect to generate £400,000 then you can warrant a revenue valuation of £800,000.
Also having an idea of what other businesses in your sector have exited at will give an investor a good indicator of what kind of return they can expect on their investment (if all goes to plan). But note that only one in a thousand startups meet or exceed their revenue predictions in their planned period. This is why being able to show traction will make your startup so much more valuable from the perspective of a potential investor.
Of course, if you cannot show traction you could still find you funding, but you will probably have to give away a larger slice of equity. The secret is knowing when to stop being small, seeing the competition stealing your business and knowing when to raise capital.
