HOW TO VALUE A STARTUP

Company founders often seek to sell part or whole of their companies for a variety of reasons including:
 

  • to cash out

  • to retire

  • to raise cash for operations

  • to settle outstanding liabilities or warranties

  • to bring in investors for strategic reasons


and more...

There is not one correct way to value a company because all companies are different.  Even branches of a franchise chain such as McDonalds may have different valuations due to their location, sales figures and the make-up of their balance sheets.

There are certain very wrong ways to value a company.  See here.

 

Accurately valuing a company is critical to ensure that the owner is not short-changed.  Over-valuing the company is certainly not desired as that will drive investors away.

 

Valuing a company is very much an art.  

 

Nonetheless, there are several technical methods to value a company. These methods, while crass, are widely adopted by practitioners like Angels and Venture Capitalists.  Some methods include:
 

  • the multiple of Revenue method

  • the multiple of Price-to-Earnings method

  • the Discounted Cash-Flow (DCF) method

  • the Net Asset Value (NAV) method
     

and even more bespoke methods such as:
 

  • the Notice of Assessment(NOA) method

  • projected sales per distribution method

  • applying a floor of the paid-up capital

  • founding team's past successes

Depending on the stage of the company, one method may be more suitable than the other.

 

HOW NOT TO VALUE A STARTUP

  1. Avoid valuing an idea.  Investors invest in TRACTION, not ideas.
     

  2. Pegging To A Competitor's Valuation.  
     

    • All deals are different.  There is no way to know the intricacies of a deal based on published valuations.  

    • A competitor's deal may consists of contrive setups involving syndicated deals or contingencies that when not met, may completely change the original valuation.  For example, the valuation may be halved if a milestone is not met.

    • Accordingly, your negotiation position may be severely affected in the event you are found to be unfamiliar with the structure of the competitor's deal and valuation.
       

  3. 1% of market size.  This is the number 1 mistake.  Do NOT start a pitch with:

    "the market size is $X-billions.  If only 1% of the market buy from us, the company will be worth $x-millions"

    Anyone can make blanket arguments like that.  If it is true, then anyone (including the investor) can enter said market to start a competing business and give you a run for your money.  Such a start is at best, a childish attempt to distract the investor away from the secret sauce that is worth paying a premium for.

     

  4. Too Long A Back-Story.  Generally speaking, the longer the back-story, the worse the deal.  During the pitch, emphasis should be placed on realistic and achievable plans to garner sales and cashflow.  Do not dwell on anecdotes.
     

  5. Expect Investors To Be Believers In Day 1.   Investors are seeking to get a financial return because they themselves are in turn, accountable to their asset owners.  Everything has to be based on facts.  Not documented means not done.
     

  6. Being too technical.  Never enter a technical discussion UNLESS it is brought up by the investor himself.

 

HOW TO NEGOTIATE A DESIRED VALUATION

  1. Establish the Zone Of Possible Agreement (ZOPA)
     

    • lower limit capped by valuation in last round​

    • lower limit capped by paid-up capital
       

  2. Adopt a contingency.  For instance, a lower valuation if certain milestones are missed. 
     

  3. Negotiate From High Grounds.  Negotiate only when the company is in the pink of health in terms of cashflow and prospective deals such as the fulfilment of contracts and signing of Memorandum of Understandings with large organisations.  Never discuss valuation when desperate as investors can smell desperation a mile away and can capitalise on it to gain a huge discount.
     

  4. Legalise the valuation by having previous buy-in.  For instance, sell small pockets of shares at high valuations.  Complete due paperwork such as signing of contracts, lodging of Annual Returns and payments of stamp duties to the Authorities.  
     

  5. Give great discounts to advisors or anyone who can improve the business.

 

PRINCIPLES OF DISCUSSING VALUATION

  1. Be humble but display quiet confidence.  The investor is investing in the founder as much as in the business.
     

  2. Articulate the investment opportunity in 90 seconds or less.  If the concept is too complicated, demonstrate a use-case.
     

  3. Know your numbers.  Emphasise on the various income streams.
     

  4. Be prepared to give a HUGE discount to a deserving investor.
     

  5. Be prepared to give FREE shares to a very deserving investor.
     

  6. Avoid valuing an idea highly unless you and your team have a great track record that you can capitalise on.  For instance, past sales successes, magnificent exits, huge credibility etc.
     

  7. Know that "traction" refers to: Distribution, Investors, Sales & Cash.
     

  8. A bird-in-hand is worth two in the bush.  Accept an offer if you are not sure.  Take that cheque first.  You can always return the cheque later if things go south.
     

  9. The Alternative Test.  If the investor can replicate what you are offering for less than what you are asking for, you will not get a deal.
     

  10. The Exit.  Focus on when and how the Investor can exit.
     

  11. Mitigate The Risks.  Wherever possible, apply:
     

    • Personal Guarantees within limits.​  PG can be removed when milestones are achieved.

    • Structure the deal as a Convertible.  It offers investors the down-side protection of a Debt but the up-side of Equity.

    • Beat the banks by offering a superior interest rate.  For instance, 4X the payouts of whatever banks are offering.  

    • Rights-of-first-refusal. 

    • Capital Call Schedule.  Investments are paid out in tranches only when milestones are achieved.

    • Appointment of 3rd party administrator as an audit and compliance control.
      and more.

    • Matching the investor's dollar.