As part of Global Entrepreneurship Week, the DomPost published an interview with me headlined “Passion a crucial ingredient for success” on the relationship between angel investors and wannabe entrepreneurs, which is available online.
They haven’t published my take on factors that affect valuation online, so I’ll take the liberty of reproducing them here.
Valuations are very subjective, and it takes someone with significant domain expertise to even hazard a guess. That’s one of the reasons that angels like to syndicate deals – nobody is an expert in every domain.
Factors that effect valuation include:
- Team: Track record (both success and failure), commitment, passion, ethics
- Financials: Realistic cash flow forecasts, ability to do things on the cheap, and future capital requirements
- Product: Uniqueness, simplicity, how much pain it will alleviate
- Sexiness: How “hot” is the product and the space?
- Market: Size, addressability, familiarity
- Sales strategy: Customer acquisition cost/effort, ability to execute
- Business model: Rapid scalability, flexibility, operational complexity, robustness of assumptions
- Intellectual Property: Patents and other barriers to entry for potential competitors
- Competition: Can someone else easily squash your startup?
- Hygiene: Governance, tidy accounts, good legal agreements, no outstanding law suits or significant legal risks etc
One thing’s for sure: your company becomes a lot more valuable the day you sign on your first batch of significant customers, and is worth more again the day you become cash-flow positive.
It’s a surprise to many entrepreneurs that cash-in (ie, how much as been previously invested into the company) has little impact on an objective valuation – it’s a highly emotional issue that is often a real roadblock to doing a deal.
For a bit of fun, see Cayenne Consulting’s High Tech Valuation Estimator.
If you’re more serious about it, local companies like Valuecruncher provide reasonably priced objective valuations. The Angel Association / NZTE’s Escalator Service also does a great job of helping companies become investment ready, part of which is arriving at a valuation you’re comfortable with.
It’s a truism to say that your idea or company is only worth what someone is willing to pay for it. Don’t fall down the hole of holding out for an impossibly high valuation, as the real value in a high-growth company is its ability to outstrip that initial valuation quickly. Most investors will completely shut off when you give them a number that’s an order of magnitude out from what they think your company is really worth, and you may not get a second chance.
So instead of insisting that your company or idea is worth a lot more than your potential investor thinks it might be worth, ask what your investor can do to ensure that your company will have the resources and expertise it needs to realise its full potential.
2 comments ↓
Is there potential to reach agreement through conditional valuations? I think the market potential is much bigger because I’ve identified four segments where the product can be applied, but you disagree because you think only two will pick it up. We agree a metric that indicates which is right, and if that metric goes past an agreed point the valuation is different? Fraught, I realise, with the potential for metric management and general distortion, which is why I ask if they occur.
Danielle, what you suggest is fairly easy to implement through convertible notes. With a convertible note, the investor lends the company a set amount of money, and there are specific conditions that will trigger either repayment of the loan, or the loan converting into equity at a rate according to a pre-agreed formula.
As a simple example, an investor might agree to invest [$200,000] in your business on using a convertible note; if after one year your sales are less than [$200,000] then the loan would convert to shares at [$1] per share; if sales are greater than that then the price would be [$0.50] per share – giving you a big incentive to make the company perform.
You can get a lot fancier with the formula, and the investor will likely want security over the whole company and its assets, so that if things really turn to custard they can step in and either run the company themselves or liquidate the company in an attempt to make good on some of their loss.
Convertible Notes can be useful in some circumstances, but I generally prefer straight equity deals with few strings attached because I like to get involved very early on. They can also complicate the situation in further capital raises. That said, so long as everybody understands the limitations, they can be a useful tool in exactly the situation you describe.
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