Written by: Magnus Ernegård, Executive Contributor
Executive Contributors at Brainz Magazine are handpicked and invited to contribute because of their knowledge and valuable insight within their area of expertise.
So, now you decided to take on some external equity capital, and there are interests from a couple of investors. You have done the due diligence on the Business Angels in question,
and you feel it is a good fit. You also defined exact amounts and when you need them, and how you will use the money. Further, you made an in-depth future funding rounds planning, which, of course, aligns with your financial plan, growth strategy, marketing, and selling expenses and is also in line with the team-building. Additionally, you completed a thorough and well-structured risk analysis with mitigation activities if not reaching your milestones, revenue, and profitability. You are now on a good way on the journey to be investment-ready
with your startup.
Well done so far! Now you should prepare for the big thing – to agree on a Pre-money valuation of your Startup with the investors. The investors will most likely select the valuation method/-s that is/are favouring them and most likely the one with a lower valuation outcome. So, be well-prepared and be aware of how all methods and models function and how you came to the assumptions, prerequisites, and other input and factors to the various techniques.
First of all, there are no exact formulas for determining early-stage valuations. And there are far more than the dozen methods as below to value an early-stage venture. The three at the top are perhaps the most common ones.
In this relatively short article, we will not go through and present all the variants of methods and how to calculate and do a valuation. There are numerous books, guides, academic reports, excel models on the web, and other literature explaining the different methods and their pros and cons. What we at BridgeToAngels do when assessing the Startup's valuation is by using a developed mix or rather a hybrid of several valuation methods, which usually ends up with a viable rough estimate we then have as the ground?
We begin with comparing your Startup to other Startups that have already closed a funding round and got a pre-money valuation or made an exit. The ambition is to look for similar
ventures with the same stage of development, similar team, founder's experience, similar market segment, and customer traction, similar technology and offering, and in the same area or country or city. It is, of course, a challenge to get a list of lots of ventures similar to your Startup in relatively more minor markets like the Nordic countries. If you don't find many or any ventures matching your Startup locally, try then international databases and platforms from Business Intelligence companies where you likely will be able to compare your Startup. There are many choices, from the less expensive Crunchbase and the newly re-launched Mattermark, PitchBook, or Tracxn to the highly-priced and comprehensive CB Insights or from other BI-players.
You could then either sign up for the service yourself through a subscription plan directly with the BI providers and be prepared to pay a pretty high fee, of course, depending on the magnitude and quantity of information you will get. Or, you can use a Startup support provider if you only are going to use the data more occasionally and together can dissect, elaborate on, and structure. In any case, you must have a good grip on the potential competitors' valuation, funding successes, and who the investors are, and analyse industry trends? You will then be able to quickly take action on signals in the market, have confidence, and show credibility when discussing with your investors and your team.
The relative- or comparison valuation methods, which outcome can vary significantly from year to year, are as mentioned based on finding an average value in an industry by comparing similar ventures and then using that average to determine a relative value. If the industry, your competing ventures, or your Startup has experienced a year of unusual circumstances, the relative valuation must be accounted for. So, it is essential to understand the figures behind the comparable ventures in detail if the multiples varies a lot.
We see, though, that some comparison factors have relatively little impact on the valuation result. But, other stages of development and market traction have a significant effect. So, if you find a good comparison where most of the factors match, we recommend you adjust the valuation up or down to compensate for the difference.
Before defending your valuation with the potential Angel investors, try to make and calculate as many valuation methods as possible. You could then pick and include the ones you feel are the most reasonable methods. You will, by that, be able to make well-structured reasoning about the similarities between your Startup and the respective ventures and how you came to the Pre-money. Or rather acceptable price ranges of what the valuation is for similar ventures at particular stages.
Your well-argued and well-substantiated valuation proposals will then impress the potential Business Angels!
Market expectations
The valuation is, of course, the value that the market can bear. So, the valuation is what the investor is willing to pay, given the risk profile and the Startup stage. We try to give the entrepreneurs as much guidance as possible based on our and our partners' experience, what investors are looking for and what we think they are willing to invest. Together with our analysis, we collect information from various Angel organizations and VC firms and other investors at any given time to try to find out the market expectations on every deal.
Without doing a proper business valuation before a negotiation, you risk either starting from a too high price and scaring away potential buyers or starting from a too low price and risking
being underpaid. Both situations are bad for you as a Startup founder so, you must focus on realistic expectations in your forecasts to make the valuation as accurate and realistic as possible.
There are also several benefits to do a business valuation on an ongoing basis. Knowing the value of your Startup at an early stage can affect its future value.
Different factors are to be considered when you are evaluating your Startup. A couple of factors that will affect the valuation are as mentioned expectations about the venture's future revenues and financial results, whether your Startup changes the rules of the game in an existing market, competitive advantages and the founders' previous experiences and successes as entrepreneurs. Be aware of the factors that can lower the valuation, like low margins, high competition, and management with limited experience. So, prepare for a discussion with your potential investors.
To increase your Startup's valuation before the funding round.
Make sure your Startup stands out. So, how do you increase the value of your business at an upcoming funding round? As earlier you start to follow the value development in your company, the more excellent the opportunity you have to influence the venture's value.
So, it is a good reason for you to do your Startup valuation at least annually to discover areas for improvement. Subject to what stage you are in your Startup- and fundraising journey, you should focus on steps and activities to increase the value of your venture. Some suggestions are making scalability visible in the venture, further developing areas that provide:
Competitive advantages.
Raising the prices of your products and services.
Reducing the cost per unit.
By, for example, increasing the repurchase frequency of your existing customers, costs will go down, and productivity will increase. Also, keeping key people on board is a good strategy because they provide stability and invaluable knowledge stays in your Startup.
As mentioned, from a pure valuation perspective, the most critical issues are recurring income, profitability, and growth. Logically, investors are willing to pay more if they see profits increase, showing a more stable and profitable future. Be sure to align your actions with your value-creating goals, implement changes by assigning the tasks to the most suitable people in your Startup. But, do not put all your energy into emphasizing as high a value as possible, but show that your main focus is on reducing the risk in your Startup by delivering valuable achievements.
So, to sum it up.
By doing continuous valuations on your Startup, it should be possible for you to follow the value development and see the effects of your work to make your Startup more valued.
An in-depth understanding of all possible valuation methods and their outcome for your Startup is crucial. Feeling well prepared about your investment readiness helps increase your confidence when discussing items like below with the Business Angels (and VCs).
There is a clear and compelling value proposition: You solve the customer's real problem and show a market demand.
There is an exciting investment opportunity: You have attractive and credible financial prospects with exit potential.
There is a market opportunity: You have a defined target market that is large and growing.
There is an executing capability: Your team is "hungry" and has high ambition with a strong willingness to carry through. You also have a solid go-to-market and growth strategy with scalable potential and a firm understanding of identifying, managing, and mitigating risk.
There is a competitive advantage: You have a superior and solid value proposition that can protect against competitors and create an attractive position for your Startup.
There is a great team: You are a committed team that have relevant domain knowledge and a strong track record.
To demonstrate investment readiness is about ensuring that investors' expectations are met and that your Startup possesses the most important drivers of the venture's success. You should have a robust, validated route to generating the financials (with or without ESG parameters), and that you have a good understanding of the values, interests, and expectations of the potential Business Angels.
There has been a growing acceptance from the investors of virtual meetings and investment web forums during the pandemic's last 1 to 1,5 years. It means there is and continues to be many more potential Business Angels out there looking for an increase in deal flow. With a good selection of international early-stage investors with whom you might get access and build relationships, this could give you additional knowledge and perhaps financing, so use your network!
Finally, be sure to get the latest status regarding the Business Angels' current portfolios and where they previously have invested and in which ventures, industries, ticket sizes, business models, investment stages, and geographical areas. If there is an Angel Syndicate, make sure to know not only the lead investor but all players in the Syndicate because you will and should communicate with all of them during your Startup journey.
So, until next time, keep on Starting up!
Magnus Ernegård, Executive Contributor Brainz Magazine
Magnus Ernegård has over 30 years of senior management experience from different industries in multinational industrial companies in various countries. Background in CEO positions, CFO, management consultant, production, business development, innovation, corporate governance, and entrepreneurship. Further, he has, over the years, gained Board and Chairman experiences from Boards within the Automotive, Logistics, IT Consulting, and Textile industries.
Today, he is the owner and founder of the Startup support provider company BridgeToAngels based in Sweden and Denmark.
Magnus has a proven track record in starting/developing businesses, company split, corporate exits, and organizational effectiveness.
Magnus also serves as Advisory Council Member of Gerson Lehrman Group. He holds an MSc from the University of Lund, Sweden.
