In his recent post for The Next Web, start-up consultant George Deeb gives entrepreneurs some simple rules of thumb on calculating your start-up’s valuation in a way that will match investor expectations. Here are his 6 key tips:
Supply and demand. You have to show investors that you are in demand. One way not to do this is to have an investor thinking that they are the only investor interested. Also make sure your business comes off as new and unique; a competitive commodity business — a “me too” story — will be less appealing.
Your industry. Typically, each industry each has its own unique valuation methodologies. If you are a next-gen biotech company, for example, make sure you’ve studied the valuations achieved in recent financings or M&A transactions in your field.
Your stage of development. This is a key driver in determining valuation. Deeb has put together four stages of start-up growth using web companies as the example, calling his stages “not too dissimilar to four years of high school education.”
- Freshmen: a piece-of-paper-to-beta site (bootstrap financed — raise $50K to $500K).
- Sophomores: a beta-to-full-production site with initial users (seed stage angels — raise $500K to $1M).
- Juniors: have achieved full proof-of-concept, rapid user or revenue growth, approaching up to $1M in revenues (Series A venture capital — raise $1M to $5M).
- Seniors: have grown to multi-millions of revenues, ready to materially scale their businesses with a significant capital raise (Series B venture capital — raise $5M to $50M).
Valuation techniques. Investors will study your business’ revenue, cash flow and net income multiples by looking at recent financings in your industry, recent M&A transactions in your industry, and other factors. Multiple ranges can be very wide, and they can range substantially within and between industries.
The number one driver of your valuation, however, will be your forecasted earnings growth. If there are no earnings yet, investors typically look at revenue multiples or some other metric. And if there are no revenues, unless you are a biotech company awaiting FDA approval, raising funds at any valuation will be very difficult.
Rule of thumb. Investors see deals all the time, and are typically tuned into what’s happening in the market. Thus, they will have a pretty concrete idea as to what your business is worth to them. The best thing to do is to collect a few term sheets from multiple investors, compare and contrast valuations and other terms, and “play them off each other to get the best deal.”
Back into a valuation that gets your investor a 10x return. Make sure your five-year forecasted financials will grow large enough in that time frame to afford your investors a 10x return. This means you need a credible sales and marketing plan to realistically achieve these levels. “Most importantly,” Deeb writes, “you need to put on the hat of your investor in setting valuation to get them excited about your start-up vs. the hundreds of other start-ups they see each year.”
Source: The Next Web
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