Of all assessments to be made before presenting your company to investors, the most important, and least simple, is valuation. Early-stage businesses lack historical financial records that can render valuations fertile ground for guesswork. The vocal but assumptive nature of the industry on which valuation is based casts forth its fair share of prophets, but companies need to balance realism with idealism when casting their own valuation. For this reason, it has been labelled “an art rather than a science”.
Conventional wisdom dictates that market size, frequency of recent exits, and the existence of any established investment are the key tenets dictating valuation. The vast range of valuation methods, however, indicate this science is far from being exact, and the many factors at play must be assessed. We’ve addressed the essential factors below, to discount unnecessary assumptions from affecting your valuation decision.
1. Relevant factors
Basic economics states that demand affects price; investor appetite strongly correlates to a company’s valuation.
No single factor can determine the favourability of your company by an investor, but there are certain that are guaranteed to be beneficial. Traction is chief among them, as nothing boosts investor confidence as demonstrating an established or growing user base.
Similarly, reputation encourages investors, even when the individual concerned may not have a hallowed track record of prior exits. Pinterest is one example where the founder, Ben Silbermann, raised high amounts in the first round from his entrepreneurial image and effective marketing strategy. These alone can eschew the relative lack of traction or reputation.
2. Projected growth and exit
In the all-consuming sprint for high valuation, it is common for companies to ignore the consequences of this goal. Attaining that high valuation at seed necessitates a higher sum for your subsequent round, and relative growth. Investors are looking at the eventual amount they will receive – hence your exit strategy becomes a key consideration for investors. Looking at an IPO? Investors may scatter, due to the difficulty of attaining one. The amount of investment to be expect should be depended upon the amount investors can expect to recoup and your preferred exit strategy.
3. The current market
From the outset, valuation should be assessed by the present state of play of the market in which your company operates. Investors will be looking directly towards exit price, based on an assessment made by the present size, proliferation and success of that particular market. Use these as the platform from which your current negotiations are formed. Typically, 18 months is the period beyond which investors expect growth.
4. Your target investor determines the valuation amount
Your investor will find similar companies and figure out their valuation to revenue ratio – the multiple. Then they multiply your company’s revenue by that multiple, to determine the valuation. After taking into account comparables (similar companies) and discounted future cash flows (future intrinsic value), a valuation will be made.
Businesses need to factor all of the above during the negotiation-like process of valuation. Overall, the valuation process provides ample opportunity for businesses to assess their marketing strategy, plan growth and demonstrate their potential and talent. This has the cumulative effect of not only attracting investment and attaining an accurate valuation, but offering a framework of the company in which to subsequently operate. In using valuation methods to reach an approximate figure, businesses should be canvassing their strengths and weaknesses in the same way potential investors will – this will bring you closer to attaining that perfect investor and accurate valuation.
Richard Andrée Wiltens is a commentator within the fintech sector, who has written for an array of international investment platforms. His career has spanned from investment banking to financial technology firms, backed by an education in economics and finance.