The internet is littered with stories of astounding startup valuations, achieved within just a few years of a company’s birth. I think my favourite in recent months is the aptly named Improbable, a UK tech simulation company, which raised $502 million (£390 million) in a funding round in May 2017 at a valuation of over $1 billion, making Improbable a unicorn (a business valued at $1 billion or more). The company was just 5 years old.
Are such valuations the stuff of dreams, make-believe and fairy stories? (Surely that choice of the name “unicorn” isn’t used without irony!) How do you value a startup in the real world?
“A startup needs money. It makes the dream come true.”
Now, don’t get me wrong. I expect a founder to be bullish and full of optimism for their business. No one is going to invest in a business you’re not excited about. The issue here is that investment for early stage businesses is vital. It is literally the lifeblood. It is what enables you to build your prototype, test routes to market, build market understanding and provide the funds for growth. A startup needs money. It makes the dream come true.
“A “deluded valuation” can close doors before you’ve even had a chance to say ‘Hello'”
But, a “deluded valuation” can close doors before you’ve even had a chance to say “Hello, I’m Rumpelstiltskin”. Why would you close doors before you’ve even started a conversation?
Established businesses have it easy. When you’ve got predictable revenues there are numerous ways to assess and measure business value. (If you ever find yourself having trouble sleeping, take a look at this Wikipedia article listing ways to value a business. Startups and early-stage businesses are anything but predictable – they may not even have revenue. In such circumstances, the only business valuation that matters is when two parties agree to buy and sell.
“The only business valuation that matters is when two parties agree to buy and sell.”
But how do you get to that point? Where do you start? How do you evidence your valuation? How do you negotiate to reach agreement?
Startup valuation is a negotiation – but not one that exists in the founder’s head. One that is grounded in fact, displays careful planning and contains a dose of realism.
There is nothing more likely to cause a potential investor to walk away than a business valuation justified in the following was:
“I’ve looked on crowdfunding sites and another company that’s not as good as ours is valued at more”
“That’s how it’s done “in the Valley””
Instead, real world valuation starts with:
- Facts – that demonstrate what you have achieved in the business and that there really is a market that is willing to buy what you offer
- Financial forecasting – not “finger in the air” stuff, but grounded spreadsheets that demonstrate a founder’s understanding of market drivers, costs and diversified revenue streams
- Strong team – the right people with the skills and experience to make the financial forecast a reality
- Credible exit – which demonstrates not just an attractive return for investors on paper, but a believable route to selling shares so that the return can be realised.
Then, it’s a conversation between grown-ups – exploring assumptions, plans and options. The length of that conversation being tempered by the speed at which the business needs the investment!
By Hatty Fawcett, Focused For Business
If you want to learn more about practical business valuation for startups, sign up for the live and interactive online masterclass “How to create a business valuation that gets your startup funded.”
You might also like “How to value your startup: A brief, practical guide.”