Many finance valuation methodologies used in the past don’t work all that well for early-phase startups. DCF, or discounted cash flow, will include a suitable technique for established businesses which possess a cost and revenue history.
Assumptions concerning marketplace growth rates, marketplace share, gross margins, as well as additional variables may be made to deliver scenarios which will set up the valuation range. Those assumptions can’t be properly approximated for the early-phase startup, and that makes results questionable. P/E (price/earnings) multiple isn’t appropriate, as many early-stage companies are losing funds. P/S (price/sales) might be utilized if an organization has generated sales for a couple of years.
Many VCs that are investing in early-phase businesses will utilize two different business valuation techniques to set up the cost they’ll pay for investments:
- The latest comparable financings: A venture capitalist will identify like businesses, in stage and sector, as an investment opportunity. Multiple databases—which include VentureXpert, Venture Wire, as well as VentureSource —may offer details which set up a range of valuation for comparable businesses. But, transactions which are over 2 years old aren’t considered market. Though some details might not be publicized, most VCs and entrepreneurs understand through word-of-mouth what those latest valuations have been for comparable businesses.
- Possible exit value: Venture capitalists and additional investors have an excellent sense of an organization’s exit value. This value may be based upon recent M&A (merger and acquisition) transactions within the industry or the valuation of likewise public businesses. Many early-phase investors search for 10 - 20 times ROI (return on investment) (later-phase investors usually search for 3 - 5 times ROI) within 2 -5 years). For instance, assume the exit valuation of about $100 million. The venture capitalist owns 20 percent of the business at the exit time. The venture capitalist is going to make $20 million on their investment during exit.If a venture capitalist invested a million in the organization, they are going to make 20 times the investment. If a venture capitalist owned 20 percent for a million dollar investment, the post-funds valuation of an organization during the period of the original investment was five million. As you’re able to plainly see, investors utilize the post-funds valuation in order to estimate the cost an investment has to command as they sell the business or exit.
How to maximize the valuation
Make an excellent case. Show an investor why there’s massive possible exit value for your business. • Maximize the possible exit valuation by eliminating any obstacle or doubt which an investor perceives as restricting the upside valuation. For instance, if you have gaps within your management staff, identify the individuals that would join the staff after funds are secured.
Conduct your research. Know the valuations of additional businesses at somewhat later phases. Identify and know the gaps (commercial or technical) between your company and theirs. Then, concentrate your organization’s business plan to closing those gaps. • Locate the investment competitors. If there’s competition for the deal, the investor will be more than likely to provide a higher valuation. But, investors may speak to one another, therefore don’t, "play that card," if your competitors don’t exist.
Business valuation knowledge
Keep in mind the following while going through the process of business valuation with the investor: • As you’re initially offered a valuation, request a higher valuation. Pushing back will demonstrate that you are confident in your company and that you are an excellent negotiator. When pushing back, of course, offer arguments and evidence as to why that valuation ought to be greater. Request a valuation which is 25 percent greater than the initial offer, according to Guy Kawasaki’s The Art of the Start.
Take the funds and get to work if the offered valuation is reasonable. Within most instances, companies either make more cash than they dreamed they would, or they don’t work, whatsoever. Neither the valuation nor an investor’s certain percentage will significantly affect an organization’s eventual success. • Speak with your board members, advisors, consultants, and additional industry players in order to decide if the deal you are receiving reflects present valuations. • Think about taking a lower valuation from a "better" investor, if you believe that this investor will be the one to bring more to the table than the other.