Posted: Mon 31st Dec 2018
Finding a fair valuation that is attractive to an angel investor but also leaves the founders happy is perhaps one of the trickiest parts of the process of seeking investment. Crowdfunding consultant Adria Tarrida shares some tips to leave everyone satisfied.
So, you have a great idea or product, traction on the market and you need some money to scale it up. You'd love some investment, as you won't need to repay it short term, and perhaps even some 'smart money' that opens doors in your market. Angel investment seems a great fit, but there's a big question: how do I value my company?.
This article provides guidance on how to arrive at a sensible valuation that helps to attract investment while at the same time leaves you happy.
What does a good deal look like?
As a business owner, you need to get enough money to execute your business plan while giving away a relatively modest share of your company. There might be also the desire to get 'smart money' on board but the risk of getting investors on board with an agenda that does not align with yours.
An investor's main concern will be getting a good return for their investment. They do know that most of the companies they'll invest will fail to make a return, so they'll be looking for those that can give them 7x to 10x (or more) return.
That means a solid solution to a real problem, in a market that is big enough and a credible business plan.
But mainly, they'll be investing in a great team. 'Back the jockey and not the horse' is a sentence you hear quite a lot amongst angel investors.
To meet those seemingly contradicting positions (give as little as possible from the entrepreneur vs. 10x returns for the investors) you'll need a solid valuation that you can defend.
The traditional methods and why they don't work for start-ups
For established companies, accountants and investors have been using several methods to enable a potential sale. Unfortunately, the unpredictability of a start-up means that they don't work for early stage ventures. Let's take a quick look at them:
Discounted cashflow: This assumes that you have historical data and that with it, you can extrapolate to future performance. However, by its very nature, a young company will not have enough data to inform the valuation.
Net asset basis: This assumes that the company has tangible assets, such as machines, buildings, etc. and intangible assets such as IP and brands that have a defined value. Again, this is rarely the case for a start-up, and the method will not be useful when we're trying to put a value to our company.
Multiples of comparable transactions: Typically, a mature company is valued at around 3x its revenue or 10x their EBITDA. These numbers change from sector to sector and finding comparable transactions would help giving a more accurate valuation for a company that's been trading for a few years. Still for a company that's just starting to get revenue through the door (or even worse, it's pre-revenue) this would leave a very low valuation. Not very helpful, is it?
It's also worth considering that none of these methods consider the quality of the team or the motivations of the Angel Investor or syndicate. We'll need to take a fresh look with other methods.
Some methods that might work for a start-up
Rules of thumb: Different angels will have different rules of thumb for different industries. For example, they might think that a software company idea stage might be worth £250,000 at most, while if it has a minimum viable product (MVP) with trial customers, its valuation is between £750,000 and £1m. They might assign over £1m only if it's generating revenue. It's worth talking to investors asking them if they use any rules of thumb in your industry.
Finding comparable transactions: It's not easy to find angel syndicates or companies disclosing their investment details. However, Beauhurst is doing a great job at keeping track of the investment in unlisted companies in the UK. Also, you can look for similar transactions on the funded companies archive of Seedrs and Crowdcube, the two main equity crowdfunding platforms in the UK. They have filters by sector, size of raise, etc. Once you've found five or six comparable transactions, filtering out clear outliers, you'll be able to assign a value to your company, based on metrics such as revenue and EBITDA vs. company valuation.
Working backwards from an exit: To apply this method, you'll need a business plan that takes you to the point of selling your company five to eight years down the line. Needless to say, this business plan will need to be backed with sensible assumptions of how you'll grow the company: innovation roadmap, opening to new markets, new sales channels etc. It will be reasonable to apply the 'multiples of comparable transactions' at that point. For example, 3x your revenue or 10x your EBITDA at exit will give you a valuation backed by a few years of trading, even if this is only a projection. Then, you can work backwards your current valuation by using a ROI multiplier for your industry, for example, 10x.
How to arrive at a company valuation
First of all, you should be taking into account your individual constraints as an entrepreneur. They will significantly shape what lines are you ready to cross and what other lines are walk away points.
Secondly, by using parameters in your industry, you will arrive to different valuations by using the three methods described above, looking for compatibility with your individual constraints.
At this point, my recommendation would be to get as much feedback as you can. You should send your pitch deck, including your valuation, to as many people as possible, asking for their input.
There's an old saying in the industry that goes: 'Ask for investment and you'll get feedback, ask for feedback and you'll get investment'. In really, it's not as straightforward as that, but there's a nugget of truth in my experience.
By all means, incorporate the feedback you're getting into your pitch deck and adjust your valuation. You'll soon be ready to present the opportunity to angel investors.