Early stage company valuation
OPINION: Ralph Shale on equity crowdfund valuations and how investors should approach them.
OPINION: Ralph Shale on equity crowdfund valuations and how investors should approach them.
How should you value a company?
Investors should try to use a range of methods to validate what is a reasonable valuation. The only certainty in any valuation is that it will be wrong, in hindsight either too high or too low.
Valuing any business is an art not a science, with a lot of room for personal interpretation. There are a number of valuation approaches that investors can use. The best advice is to cross-check several before determining what is or not a reasonable valuation. My own approach:
Value invested to date
Although this is probably the crudest approach, it is interesting to understand how much has been invested to date to get the company to its current position. This should include both cash and an allowance for time (sweat equity). This ‘replacement’ cost can then be adjusted for the following:
The last funding round
If the company has raised money before, what was the valuation at that time? What has the company achieved with that investment to change the underlying value? How has the company performed against the business plan that secured those funds? A word of caution: although the earlier valuation is a starting point, do not necessarily accept it was correct.
Potential valuation
The two earlier approaches are backward-looking and are more useful as a reality check; the value of any business is in the future. My next approach is to try to forecast a value at some point in the future, then discount that back to a value today. Consider:
You need to consider who the next investor or buyer will be and consider how they will value the business. Then this value is discounted to today’s value taking into account:
Market comparisons
The final approach is to look at market comparable transactions. This is obviously more difficult for early stage transactions as there is less public data available and many of the businesses are unique. The New Zealand Venture Investment Fund has released data on its website on a range of valuations for the companies they have invested in, broken down by sector and stage of business.
What a number of entrepreneurs will do is try to point to other company valuations if they are favourable. Two points to remember: comparing international valuations to New Zealand's is not valid unless the company is raising money internationally and, often in angel and VC deals, the investors have good protection against companies not delivering on the valuation. This allows ‘inflated’ valuations to be reported and is not directly comparable to a straight equity investment.
Industry rules
There are some useful industry norms that will help in determining the valuation of any business.
An example:
The following is data taken from a recently successful crowd-funded project.
Based on the above analysis a pre-money valuation of near $200,000 would seem reasonable. But the actual valuation was significantly more than this.
Ralph Shale is the co-founder of private equity company Sino NZ International Investment and runs venture capital adviser I Grow NZ. He has advised more than 200 early-stage businesses since 2000, which today would have revenues of more than $400 million a year and have a market value of more than $2 billion.