Determining the value of a new startup is subjective. Many models can try to predict where the company will be in five years, but it is just guesswork at the end of the day. All parties involved are interested in the valuation of the startup, and big stakes are to be gained or lost in the negotiation. Investors want to keep the valuation low so that their potential stake in the company can be a higher percentage down the road. The entrepreneur has the same desire to maintain a higher stake in the future. A more significant proportion of equity in the future requires a high valuation for the entrepreneur. What are some of the factors that can influence such decisions? What makes them correct in their assertion? At the beginning stage of an early startup, there are no clear answers. That is unless you can accurately predict the future, of course.
As an entrepreneur, there are methods to try to get a high valuation. Every entrepreneur is eager to demonstrate how their idea is the next big thing. Most investors will take their pro forma projections with a grain of salt. To justify their high evaluation, the founder of the new startup needs to have some facts to back up their claims as evidence. The best proof is the current customers. If the newly started company already has customers purchasing their product, then the prospective angel could project out five years of sales and profit. It is important to note that with this observation, angel investors are not looking for profits at this early stage in the game. They merely want to see that people are interested in the product or service of the start up company. A solid business plan needs to be in place. The business plan will need to include market analysis and research. An investor wants to see evidence that the market is ready for your product or service. They also desire to see a lack of saturation of competitors. A quality team with backgrounds that demonstrate experience in your field will contribute toward a high valuation. Having a great plan and untapped market potential is not good enough. Proper execution is the only way a startup will be successful. Executing the plan cannot be done without a passionate, experienced, high-quality team.
Although the entrepreneur needs to prove the point that they should command the valuation they are offering, it is not good business to become too greedy. It is possible the founder may deter investment into his business both initially and in future rounds of investment. It is important to be realistic. A conversation with an investor, accountant, or attorney can bring the entrepreneur down to earth with a reality check.
Valuation of a startup is a process through which an outcome is determined by having many conversations between the investors, founders, and other stakeholders. Numbers must repeatedly run on many of the models that are available to help determine an outcome. Market analysis is essential to understanding the customers, industry, competition, and other forces at work, such as government regulation and the economy. If all parties are motivated, each will state their case and come to an eventual agreement on how much the company is worth by following the complicated process of early startup valuation.
Amis, D. and Stevenson, H., (2001) Winning Angels the 7 fundamentals of early stage investing, Pearson Education Limited, ISBN 0 273 64916 7
Wilson, F. (2014), The Valuation Trap, AVC, https://avc.com/2014/05/the-valuation-trap/, Retrieved on May 31, 2020
Hixon, T. When is a Lower Valuation Better, forbes.com, https://www.forbes.com/sites/toddhixon/2014/05/11/when-is-a-lower-valuation-better-a-conversation-with-an-entrepreneur/#3fd28416ae09, Retrieved on May 31, 2020
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