Entrepreneurs often inquire about the value of their company and if it is suitable for investment. The answer to the first question is that company value is always determined by supply and demand, or the number of buyers and sellers. The higher your valuation, the more buyers you have with a strong hunger; the less buyers, the lower the price. And, as we’ve seen in recent months, the number of purchasers may drop dramatically from one day to the next after a market fall or the declaration of a pandemic. In response to the second question, every business is investment-ready at a certain cost. Whether or not you’re ready for investment is obviously determined by the kind of investor you’re looking for. The bar will be raised if they are very demanding. At the same time, the greater your value, the more demanding they are. With only a piece of paper, you may be investment-ready. So being investment-ready is a question on what is the risk appetite of your target investor and the higher their risk appetite, the lower the expected valuation.
Given that every company is always investment-ready at a particular price, the more pertinent issue is: what is pushing my value higher, and what can I do to be viewed as investment-ready by the most demanding investors?
First, a company’s fundamentals, such as whether it has strong revenue or profit growth, high gross profit or EBITDA margins, and high returns on capital invested, are all important factors in determining its value. Of course, there are other quantitative measurements that might be useful before you achieve revenue, but investors are unlikely to accept an investment without financial projections that include revenues and, eventually, profits.
But, more crucially, value is concerned with a company’s predicted fundamentals over the following several years. If a company can demonstrate extremely strong growth over a long period of time while maintaining high margins and returns on capital used, its value is likely to rise.
The most significant factor in determining value is the predictability of projected fundamentals. The greatest values, indicated as multiples of current sales or profits, are achieved when investors are confident that the company will continue to generate significant revenues, high growth, high profit margins, and high returns on capital used over a long period of time. Investors are willing to look beyond previous performance and trust in the company’s predictions not just one year forward, but many years ahead, and pay a high multiple of those far predicted fundamentals because they are confident in the certainty of expected fundamentals. Companies that have consistently generated shareholder value have the highest level of confidence in their capacity to do so in the future. The amount of confidence in a company forecast is strongly associated with the level of risk in that company from a financial standpoint. High prediction confidence equates to little business risk, and low risk translates to a low discount rate. The lesser the risk, the lower the discount rate, and the greater the value, the higher the certainty.
The next major factor influencing company valuation has little to do with the company’s fundamentals or performance, but rather with the number of potential investors and the level of liquidity, as well as the ability to get out quickly if things go wrong and without driving down the price when selling. When an investor sells a big ticket, larger market cap businesses have the most liquidity and benefit from a liquidity premium, but smaller market cap companies are more susceptible to price declines. Private companies have the biggest liquidity discount because they are simply not liquid and rely on liquidity events, which are very infrequent, particularly as the company’s risk and uncertainty rise. This is one of the main reasons why most investors choose to invest in public markets rather than private ones. This is also why a fantastic company may have a poor value due to a lack of liquidity at a specific point in time.
As a result, we must concentrate on the company’s fundamentals as the primary drivers of its value. Furthermore, we must recognise that the younger a company is, the more unpredictable and, in particular, the less accurate its set of corporate projections becomes. This is the primary distinction between small private businesses and huge public corporations. Huge companies have a large number of quantitative measurements and a set of accounts that are typically dependable. Large-company investors are concentrating on the quantitative data that are accessible. Surprisingly, they pay little attention to qualitative measures like as management team quality, which are typically much more important to value than quantitative measurements. There is frequently little more than qualitative indicators to evaluate a seed stage or early stage company. The difficulty is to transform qualitative data into quantitative measurements. Allow the qualitative to increase the degree of confidence and lessen the uncertainty in a company’s projection. Convert the qualitative into a quantitative assessment of the company’s risk.
As a result, a company’s worth is inextricably linked to its business risks. What are the dangers? All of the variables that influence the capacity to deliver a vision and a business strategy. To be successful, you’ll need a vision to fix a broken process and disrupt the established way of doing things. You’ll need a team of people with the proper talents to carry out your vision, as well as a product and a market for it. Consumers must purchase the product, you must get traction in your initial contacts with those customers, you must have a revenue-generating business model, and you must have unit economics that yield strong returns on capital. Then you’ll need to raise enough money to operate for long enough to have an effect and demonstrate improvement the next time you need to raise money. Finally, you must sign the suitable contract, which includes a set of conditions that will govern your relationship with your investors as well as an equilibrium price that will satisfy everyone. A good bargain is one that benefits everyone. If you look at the list above, you’ll see that the qualitative elements constitute a series of risk variables known as the risk ladder. The higher the value and the more investment-ready you are for the greatest investors, the more risks you successfully handle.
The risk ladder can be ordered in the following way:
* an overview of each can be found below
If you get a ten, you’re likely to be able to raise a substantial amount of money at a reasonable price. If you’re at level 2, you’re unlikely to have revenues, and unless you have a fantastic team with a spectacular track record, you’re unlikely to be able to raise a big round, and if you can, it’ll almost certainly mean a lot more dilution than you anticipated. The lower your risk appetite, the lower your appetite should be, and you should concentrate on addressing those risk concerns to lessen the perceived uncertainty that your prospective investors will face.
Disruption’s vision and mission
Let’s begin with the vision and purpose statements. What do you intend to accomplish? What issue will you tackle, what inefficient process will you address, and how will you disrupt and innovate? It’s doubtful that you’ll be able to attract consumers, partners, or purchasers if your business isn’t disrupted, much alone staff who will be required to pursue your goal. You will struggle to fulfill current requirements in an innovative manner without creativity. What is your basic vision, and are you capable of turning it into a mission?
What is the quality of your team? What is the total number of Founders? Have they ever collaborated before, and do they think they’ll get along? What are their most important abilities? Do they have the necessary leadership, skills, and industry experience? Have they worked with major technological companies or industrial giants? Do they have a good educational background or a track record as an entrepreneur? Have they undergone rapid expansion? Do they have any idea where they’re going? Is the strategy well-defined? Is the management team, including the founder, displaying the proper set of talents to meet the company’s significant problems in the future, particularly in the next 12 months? What is the company’s culture, and how do its important employees dress? Are they doers who will follow through? Or are dreamers still pondering how to bring their vision to life? Clearly The greatest source of danger is people. The broader the appropriate set of talents, the smaller the execution risks. The more expertise, the better.
Do you have a finished product that is ready to sell? And if not, do you have the proper team to construct the product, a CTO, and do you intend to develop your products in-house or outsource them? Has your product undergone any testing? Is it effective? Is it backed up by consumer feedback? What will the product’s future look like? What proof do you have that your product is relevant to your target market? Are you still far away from revenues if you don’t have a product, which will lock the door to many VCs and investors searching for revenue? If your product isn’t ready yet, you risk never delivering the appropriate product to market or having someone else do it first.
What is the size of the market you want to disrupt? How quickly is it expanding? What are your thoughts on the market? Will you be able to reach out to the market with your initial product version? Have you confirmed the market analysis from the top down and bottom up? How many customers are you aiming for, and how much will you charge them? What is the size of your addressable market, and what market share do you expect to have in the next three years? Is your home market big enough to support a successful business? The greater the market, the better; if your market is tiny, you’ll need a huge market share to establish a significant company, and you’ll have a difficult time persuading investors, particularly early on.
Visit the Market
What strategy do you have in mind for attracting customers? Or have you already done so? Is this a business-to-business or business-to-consumer scenario? Is it a marketing or a sales play? Or is it a game of company growth aimed towards a network of partners? When do you think you’ll expand? Is it possible to expand geographically or by product? Have you launched your product? If so, what proof do you have that it is a good match for the market? When do you intend to do so, and have you gained traction since your launch? What makes that traction happen? Is it via income or through usage? Do you have the necessary capabilities, such as sales, marketing, or business development, to execute your go-to-market strategy?
How straightforward is your business model? Is it a tried-and-true business model? Or will it take time for your buyers to grasp it? Because if you don’t know how to sell your products, what price you’ll charge your customers, or whether you’ll charge your products or services at all, a lot of people will spend a lot of time looking for a business model that makes sense, it’s likely that a lot of people will spend a lot of time looking for a business model that makes sense. This is especially true in novel models like marketing, where not only does the business model not exist, but it’s also unclear what the company is offering.
Economics at the unit level
A good company is one in which the basics are reasonably clear. It’s one thing to know how much we’re selling and at what price, but it’s much more crucial to know how we generate money and how much it costs to acquire a client. All of the indicators related to customer acquisition costs and lifetime value of a client are important metrics about which many investors are well-versed and have high expectations. Create certain you have a clear understanding of how your company will make money and generate profits. Sure, some businesses have taken a long time to reach profitability, but the finest businesses are those who get there first. They don’t need to raise as much money and pose a lesser financial risk, and it’s much better to be in charge of your own destiny with strong unit economics and decide to seek additional capital when you want to accelerate rather than when you’re out of cash.
Consistency in Finances
Some may argue that the financials of an early stage company are meaningless since the statistics are so unpredictable, but investors are looking for the team’s ability to demonstrate that substantial revenues and profits will be made in the future. It all begins with a strategy and a goal. Many investors will consider this as a modest opportunity if the numbers are too small. They will also pass if the figures are too large and not based on solid assumptions, since their trust in your proposal will be too low. The many ratios, key indicators, and variables you define in your strategy will represent how you think about your company and what you will examine. Yes, uncertainty is expected, but keep in mind that if your estimates are excessively optimistic, some savvy investors may ask you to relate the price to such expectations. Beyond the plan’s long-term consistency, your financials’ short- to medium-term consistency is also critical. You must demonstrate how you will deliver your business strategy on a regular basis. What runway are you planning to establish after you raise your round of financing, and what do you want to have accomplished by the time you run out of gas? Make sure you can demonstrate your investors that by the time you need to raise money again, you’ll have made considerable progress, causing the following round’s value to skyrocket. Otherwise, there is a significant possibility of flat round, which no one wants.
Deal terms that are fair and balanced
Always try to strike a fair arrangement with your investors. It’s not a case of them vs. you. It’s a trip you’d want to take together. In whatever contract you sign, be sure the incentives are aligned. A fair and balanced contract is one that takes into account market circumstances. You will attract more business angels if you can make the offer seis or eis suitable. Always provide your smaller investors the conditions that you know you’ll have to give your bigger investors. Plan to offer non-participating liquidation priority to all of your investors; it’s just fair, and it wouldn’t be fair if you profited from their losses. Plan to provide your VC investors anti-dilution insurance, but avoid a complete ratchet until the market has shifted drastically. If you want to go on a journey with your investors, let them know that you welcome their input into corporate decision-making, whether via the board of directors or by investor majority approval. Also, provide your investors information; this is a smart method to assure that they will assist you when you need it. Don’t be overly greedy with your valuation; a balanced agreement is preferable than one where your investors must wait for the first chance to increase their shares.
Route of exit
Always consider who would be interested in purchasing your product. Sure, you might always have an IPO exit, but it’s unlikely. So the question is who will acquire the company and why, as well as if they are willing to pay a high price. Innovative purchasers are typically safer than conventional incumbents since they are more likely to have better growth and be valued on higher multiples, and if they are, they will be willing to pay comparable multiples for your company. Also, make sure you maximize collaboration chances with players that may be your acquirers; impressing them will boost their desire to purchase you. Finally, be certain that your capacity to disrupt will irritate a lot of large people if you become successful. As a result, if they execute things in a manner that is a game changer for their target clients, they will be more eager to get you on board.
So, what’s next in terms of valuation? So now you have all of the value factors. Your value will therefore be based on a mix of your strategy and its risk assessments. The venture capital technique involves calculating an exit value based on your sales, or more likely gross profits and EBITDA, utilising market multiples after three to five years. This valuation is then reduced to today’s value in order to arrive at a current business valuation. This is why the range of values may be so wide. Sophisticated investors will apply a discount rate that will vary greatly. Make sure they’re using a discount rate of at least 30%, which is the minimum return that major private equity companies use to their own investments. As a result, early-stage venture capitalists are more inclined to utilise greater discount rates, typically beyond 30%, to account for uncertainties and risks, as well as to ensure that their successes would cover their losses. As a result, the best you can do is address your risk ladder and build scarcity value by scoring well across the board. If you do, more investors will perceive you as a must-invest in opportunity, and your value will rise. There are certain rules of thumb that investors follow that are illogical.