The most challenging thing most startups and first-time entrepreneurs encounter is raising money. Raising money is hard enough -- it’s even harder when you’re pitching angel investors and venture capitalists, who get asked for money for a living.
One of the sticking points for most founders is valuation. How much is your idea really worth? If it’s just an idea, the answer is nothing. But, if you’ve pushed further along past the idea stage into an actual formulated startup with a business plan, here are five tips to defend your valuation.
1. Revenue/EBITDA multipliers
As “Mr. Wonderful” Kevin O’Leary would say, “It’s all about the sales!” If your company is already making money, great, defending your valuation can be rather easy.
For early-stage companies or startups, a revenue multiplier is more appropriate, because chances are your company isn’t making a profit, and thus an EBITDA (earnings before interest, taxes, depreciation and amortization) multiplier would give your startup a valuation of $0. These multipliers are easy to use and vary by industry, so make sure to research your specific industry’s multiplier first.
There are plenty of resources online, both free and paid, to find such information, including Valuationresources.com.
2. Number of users X lifetime value
In the tech industry in particular, the common theme seems to be acquire users now, monetize them later. If your startup or platform has a substantial amount of loyal users, this strategy could be a great way to value your company. Although perhaps not as accurate as a revenue multiplier, this method is relatively simple to use, and thus easy for an investor to understand.
Let’s say you have 10,000 users on your blogging platform, and you found that through directed advertisements or another monetization technique, each new user is worth $20 a year. If you can prove that the average user will use your platform for five years, you could argue that the lifetime value of your user base (10,000 X $20 a year X five years) makes your blogging platform worth $1,000,000.
3. Discounted cash flows
If you haven’t made a penny yet, one of the best ways to put a value to your company is by projecting how much cash your company is going to generate for your investors in the future, and then “discounting” that cash back to today’s value.
Beware, DCF analysis is complex and can be difficult to use due to the number of assumptions you’ll have to get the investor to buy into -- the discount rate you’re assuming, the amount of revenues you’re projecting to make in future years, and the number of years out you’re projecting.
Generally speaking, the further out you’re forecasting (three, five or 10 years), the less reliable those projections are. However, if your assumptions are reasonable, and your understanding of the cash-recovery process is adequate, then this method of valuation can prove valuable because it tells the investor that you’re valuing the company based on how much money you can pay back in the future.
4. Comparative analysis
Sites such as AngelList and Crunchbase can give you an idea of how companies in a similar space are being valued. AngelList also allows you to see what other startups in your city raise at, which is helpful because a mobile app developer in Phoenix will generally not raise at the same valuation as one in Palo Alto.
Beware: Just because both your app and Snapchat allow users to share photos, it does not mean your company is also worth $10 billion.
5. It doesn’t matter
At the end of the day, 1 percent of $1 billion is a hell of a lot more valuable than 100 percent ownership of zero. When raising money, focus more on how much money you need to raise to make your company successful, instead of what gets you the best “deal.”
The only time valuation matters is when you’re ready to sell, which brings me to my final point: Your startup’s true valuation is exactly equivalent to what someone is willing to pay for it.