How Do I Value My Startup?

I am often asked what is the value of my business or how much ownership do I have to give up. Too often a potential client insists their business is worth millions and investors would be falling over themselves to rush to give the business owner millions for a few percent ownership.

There are thousands of pages written about how to value a startup or pre-revenue company. Before proceeding with yet another page on how to value your startup I’ll give you the simple answer. A business, like anything, is worth what someone is willing to pay.

For owners valuing their business is often an emotional exercise. For investors it is a logical exercise in math.

Each business sector has an accepted multiple to set the value for companies generating revenue and profits. Depending on your sector the multiple is either times revenue, EBITDA, or profit. E.g. at 3 times revenue, if you have $1 million in revenue your business is worth $3 million. If you have revenue and no profits usually the multiple will not apply.

Pre-revenue companies present a bit of a challenge in establishing a value and more of a challenge in making the case to investors your company is worth what you say. The formula for your value is to divide the amount of money you seek by the percentage you are offering. For example if you are offering 10% ownership in exchange for a $1 million investment you are saying your company is worth $10 million dollars. If you have no revenue, profits, or liquid assets, you must make the business case of why your business is worth $10 million.

Investor formulas, and areas of importance, for valuing pre-revenue companies vary. One Angel Group had a simple formula for the starting valuation: the Angel’s investment divided by the sum of owners money invested plus the Angel’s money to be invested.  If the owners invested $1 million and want $10 million investment total money invested would be $11 million. $10 from Angels divided by $11 million equals 90% ownership. Their starting value of the Angel investment.

The final deal generally is for an ownership amount between the percentage ownership offered and the starting percentage ownership established by the investor provided the business can make the case that the business is worth their offering and the business has the talent and experience to execute the business plan and deliver the pro forma financial projections.

Making the case your business is worth what you say begins with finding investors who will consider pre-revenue companies in your sector and invests in the range you are are seeking, getting your information in front of them, and convincing an investor your business plan is realistic and achievable.

Some key areas used to value your pre-revenue company are:

Supply and demand

The economic principles of supply and demand apply to valuing your business. The scarcer a supply (your hot new patented product, or interested investors competing for the deal and driving up your valuation in the process), the higher the demand.

Before you start soliciting investment, make sure your business will be perceived as new and unique to maximize your valuation.

Your industry

Each industry typically has its unique valuation methodologies.

Before you go to investors with valuation expectations, make sure you have studied the valuations achieved in recent financings or M&A transactions in your industry (private company valuations typically get a 25 percent to 35 percent discount to public company valuations).

Your phase of the business

Are you in concept development, prototype development, pre-revenue the phase your business is at will be a key consideration in determining valuation.

Third party validation of your business plan

Often I’m told ‘this is a multi-billion dollar industry.’ Great, but are there studies showing people want your product or service or what makes your product or service unique? Are there studies showing your industry sector grows at the rate projected?

Management and Team Experience

Your business plan must demonstrate the team has industry knowledge and a track record of accomplishment. Once you convince the investor your numbers are realistic you must convince them your team can execute and deliver the numbers. Investors will look at business successes as an indicator of your ability to deliver.

Investor Return

Most Investors want a return on their money and want to exit (be cashed out) in 3 to 5 years. They want to see returns begin fairly quickly. They are not interested in pride of ownership or long term investments.

At the end of the day, the investor will have a very good sense to what a business is worth, and what they are willing to pay for it. As they see deals all the time and typically have their finger on the market pulse.

So, collect a few term sheets from multiple investors, and compare and contrast valuations and other terms, and play them off each other to get the best deal. As a rule of thumb, expect to give up 25 to 35 percent of your equity, in each equity financing you make.

There are too many nuances to valuing a startup to give you a full picture of valuing a startup. Hopefully this short post will have you thinking about establishing a realistic valuation for your startup.

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