As soon as StartUps decide on collecting external funding from investors, rather sooner than later they have to deal with the issue of their own company valuation. There is a wide range of opinions, strategies and recommendations on the topic of company valuation in the market and ultimately the point of view is decisive in how this important milestone is perceived by all individual parties involved. The current market situation on the capital and financial markets also plays an important role in where the common ground for a deal is found and how easy it is for StartUps to convince investors to invest in their company.
Especially in early stages, StartUps are often confronted with a financial demand that cannot be met or boot straped with the founders capital alone. To cover this gap, often considerable company shares have to be given out at a still relatively low company valuation to new investors. In addition, the valuation of a very young company with little historical data on revenues/sales and costs is often fairly difficult. In our experience, many StartUps avoid valuing their own company in this situation with dedicated methods and in many cases try (sometimes recommended by their advisors) to establish the valuation through a bidding process of the investors. Often, the founders’ fear of selling company shares under value and diluting their own voting rights too much at an early stage is also involved. From the point of view of most investors, this approach does not represent a risk-adequate solution for various reasons. Exceptions to this perception might be found in some bigger venture capital funds.
Moreover, most investors cluster their deal flow in investment stages and a valuation range for early-stage StartUps helps to identify fitting investment opportunities for both sides. Therefore, it is not important to have a final valuation when first approaching investors, but it helps the investor tremendously in classifying the opportunity within the framework of his investment strategy. It is helpful for founders to use several different methods for valuing their own company when determining their own valuation range. This allows a comprehensive picture to be drawn for the range in later negotiations with investors.
At this point, we would like to collect some arguments why StartUps should approach investors with a comprehensible valuation or valuation range of their own company:
The competence of the founders’ team is emphasized or assumed to be missing by the investor.
To approach investors with a comprehensive and transparent company valuation or a valuation range underlines the founders competence to have constructively dealt with one’s own financial case. What sounds logical at first, is unfortunately far too seldom the case. Frequently, investors are presented with financial cases and valuations of early-stage StartUps that are absolutely incompatible and incomprehensible with the valuation methods commonly used. The results range very widely. The financial model either suggest a multiple of the invoked valuation or remains permanently below the profit zone. In most cases, this is not a matter of small deviations in the risk premiums or discounts, but rather the communicated valuation range has no logical connection with the presented figures.
In such cases, it is difficult from the investor’s point of view to accredit the necessary financial competences and entrust the management with the investor’s capital. Moreover, existing investors are not always available to make up for this lack of competences and often provide selective support only. Particularly in follow-up funding rounds with potential new investors, the founding team must be able to negotiate at eye level and represent the joined interests of the venture to ensure the acquisition of further capital. Especially in bidding processes and negotiations, the founders get into unconvincing tight spots without sound knowledge of their own financial case and the resulting performance.
Prepared founder teams, on the other hand, stand out from the crowd at this point.
Time
For many professional investors, company valuation and ticket size are used as selection criteria in their own deal flow. The issue of valuation has to be negotiated sooner or later and a bidding process or lack of company valuation usually delays this process unnecessarily. At this point not only investors lose valuable time. On the StartUp side, the process can also lead to results that threaten the existence of the company, in that the funding process drags on too long if the lead time is too short. Especially in the current market situation, this is often the case.
Side note: A serious offer from the investor’s side should also be based on a range at an early stage after reviewing the initial documents. Specifically, an investor can only give a final company valuation after he has carried out his audit/due diligence.
Capital market rules and professionalism
Certainly a somewhat weaker argument, but at the end of the day the founders decide to finance the company with equity capital from third parties. They are entering the same capital market regulations as more mature companies and are therefore subject to the same professional entitlement by other stakeholder groups, e.g. government bodies such as tax offices. A plausible company valuation protects both parties from taxing aspects.
The decisive factor is the signal from the founders, to have dealt with the valuation issue and the associated competence accordingly and are interested in a fair pricing process. Discussions about the amount of individual risk premiums or discounts are usually subordinate.
We recommend founders to always deal with several different valuation methods and company values. This gives the founding team a holistic picture of the valuation range of their own company. The consideration of different scenarios (management, worst, best) can also prove helpful in later discussions with investors.
On relevant sites, you can already find extensive tutorials on how to apply the different valuation methods. In our blog entries regarding the different valuation methods you will find some aspects of the respective valuation models.
If you need help with the valuation methods for your startup, contact us or come to our free StartUp consultation.
