Value is in the eye of the investor… especially in start-ups

Valuing start-ups and small businesses causes no end of disagreement with investors. The bad news is there is no right value for a business, no single way of doing it and every situation is different. That is actually the point.

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I’m a venture capitalist and have presided over a lot of deals in a number of funds. The simplest way to sum up the whole valuation thing, or “what is my business worth?” is; “what will investors pay for it?”

Value is in the eye of the investor. If you don’t like what someone will pay for say, 30% of the shares of your business then you can of course reject their offer of investment and look somewhere else. Nobody will force you to take the investment at the price. However, you might find nobody is prepared to pay what you think it’s worth.

It’s easy to be enticed by the sky-high numbers reported for pre-revenue or cash generating businesses, especially in web/social/IT but these deals still only apply to a lucky few. History tells us that many are being over valued at the moment but that’s a subject for another day.

So what should you do about valuing your business? Get some advice from someone who knows what they are doing and will be impartial, accountants are a good start. A credible one who works with investors, ask them what deals they have done.

In the meantime the following points might help you think about it a little.

1. Any business, whether it has sales or not at the moment, is worth a multiple of the future cash it will generate. I suggest you forecast your sales and profit at least 5 years ahead.
2. Even with a “freemium” model where you are collecting users at some point the users must generate cash or value somehow.
3. Forecasts contain assumptions so please base them on something other than “we aim to get 1% of the £1 billion market for ice-cream”. The clue is base them on bottom-up figures building sales or users not top-down wish lists.
4. To interest investors you have to build a business with serious growth potential so that when they come to sell their share, with you presumably, (or list on a stock exchange) there is still future growth potential for the new investors. Funny how many people I see who don’t think about this…
5. What really interests investors is the difference between the price now, that they will pay, and the value when your business is sold. That’s their return on investment.
6. Please also don’t forget you are asking investors to take a risk and they will probably price that in so as a result offer you a worse price than you expect.
7. So you need to pay attention to the exit or have a plan as to who might buy it and when in the future.

So what methods are there to calculate the actual value? Lots, we don’t have the space here and there are many books and documents on the web. Look up NPV, P/E ratios and any one of several simple books like Lucius Cary’s “Guide to raising capital for the smaller business”. Or go back for that advisor or accountant, you will have to pay for it but it will pay you back. Just remember that in the end your business is worth what an investor will pay you for a share of the equity.

Rivers Capital Partners is an independent venture capital management company. The company offers an entrepreneurs approach to venture capital, all the founders have set up and managed their own businesses.

To discuss your business idea with Rivers Capital why not attend one of their events at the North East BIC. Click here for more information.

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