- Posted on: Sep 6 2014
There are a number of ways to fund your start-up business including equity financing, bootstrapping and debt financing, to name a few. Every single which way involves business-savvy planning and careful yet aggressive execution. This article focuses on valuing your business before asking others for capital (equity financing).
Valuing a start-up business is like valuing a piece of art… beauty is in the eye of the beholder. The artist (start-up founder) typically decides their brand-new, sometimes yet-to-be-filed-LLC, no asset company is worth at least $10 million dollars because they have a $10 million dollar idea. The art appraiser (the investor’s accountant) decides the company has a book value of $500 and is probably worth $399, so a 50% stake should be available for $200. The investor him or herself usually falls somewhere in the middle. Valuation of a start-up is the art, therefore, of explaining to the investor the potential value of the million dollar idea in a scientific and meaningful way (with real numbers and real research).
Three maxims I think all start-ups should live by when valuing their idea/ company and figuring out how much to give away:
- 10% of a $100 million is a heck of a lot more than 90% of a $100,000 company. Don’t be afraid to sell the equity if that is your plan to raise money. If you don’t believe me read From Alchemy to IPO.
- Your company is worth whatever someone will pay. No matter your internal “feelings” about how great you and your company may be, if the market says the company is worth $250,000 right now, then that is what it is worth. You must therefore sell 10% of the company for $25,000.
- Your company will become more valuable over time. Selling equity should be done in phases. If your business plan is well thought out you can plan these “tranches” of capital. Maybe in round one it is $1 per unit for your provisional patent, pending trademark, great idea company, and then $5 per unit in round three, after you have issued patents, registered trademarks and have some cash flow.
The down and dirty truth is that if you do good research and can show the origin of the numbers, competing products and a rational basis for a market penetration analysis (i.e. what percent of that market you will capture and how and when you will capture it), you can tell an investor what your company is worth and get them to pay you that value.
How to get your numbers? You cannot use past performance. You cannot use price/ earning ratios. You cannot use a multiplier of trailing gross revenue. You do not have any of this yet. So, enter the speculative. You must ultimately use market comparables (comps) and financial projections. Lawyers with a business background can help you frame this issue and point you in the right direction, particularly with high technology enterprises.
Final word of warning: Be careful when using the online business valuation calculators. They are very generic, very optimistic, and barely scratch the surface of the factors involved in calculating value.
Posted in: Business Law