how to build Financial forecasts for a business - Addition Finance x Seedrs

This is a guest post by Addition on how to value your company. Addition help keep you on top of your figures so that you can move your business forward. They cover all the bases so you can excel, without Excel. Here is there step-by-step guide to building your financial forecast.

When it comes to getting investors, it pays to know your worth – or, more specifically, your company’s worth. But this might not be as easy as you think. After all, it may be business, but it’s your business – which means it’s personal. 

You might read crazy stories of US companies at the Ideation stage being valued at £3m  – and it does happen. But across the pond, the stats tell us differently. In the UK, businesses need to be at the Scaling stage to achieve a £3m valuation. This means they have:

  • product/market fit
  • proof of repeatable business, 
  • large market demand provable by data 
  • a clear path to scaling and new business acquisition
  • identified customer acquisition cost and customer lifetime value

If you’re not there yet, don’t worry – your business is still worth money, but you might have to take a more logical approach to the valuation process. This might be a bit of a reality check – but it will also give you credibility, and make you more attractive to investors. 

Why Is It Useful to Value Your Company?

  1. Raising money

Potential investors want to know how much their buy-in will be worth. You might be offering 10% ownership – but is that 10% of £500k, £1m or more? What’s the bottom line?

  1. Share Options

You might want to incentivise your team (or yourself) with a share option scheme. This benefit is taxed through the Employment Related Securities (ERS) regime – meaning you need to register it with HMRC and report on returns. Having a valuation to back up your scheme will help move things along.  

  1. Selling your business

Buying a percentage of a company is different than buying it as a whole. The concept of ‘bulk discounts’ is generally applied by buyers – meaning it pays to know what the business is worth when you enter negotiations. 

  1. Financial health checks

Periodically valuing your company will help determine if your business model is increasing its value. If it isn’t driving growth, what can you do to change that?

How To Get Started With Your Valuation

You don’t just use one method to value your company. It’s both a science and an art – the art of negotiation!

Your company value consists of four elements. Let’s take a closer look at what each one means in practical terms.

  1. Asset and Share Price Valuation

A company’s assets include tangible and intangible items. You can apply this to a start-up by thinking about your assets. You might have a leasehold, furniture, machinery or even a patent that you can list here. Maybe you’re a cafe business owner. How much did your tables, chairs and kitchen equipment cost?

  1. Net Profit Value and Discounted Cash Flow 

These represent your Present Value. Cash is king when it comes to business valuations – whether it’s past, present or future. If you’re an established business (meaning you’ve been trading for a couple of years), this is where you’ll showcase historic and projected cash flow and profits. But what if you’re a newer company? 

Discounted Cash Flow is a method of valuation based on future projections. How much cash is your company going to be generating over the next 3-5 years? Use your financial forecast to help.

  1. Revenue and EBITDA

This combination is known as Multiples. EBITDA stands for Earnings before Interest, Taxes, Depreciation, and Amortisation. The last two would apply to a business with equipment that deteriorates – like a manufacturing company. But they wouldn’t apply to a software business. 

Strip out any taxes or interest that you owe on loans – and you’re left with Earnings. Subtract any overheads like production costs, and that will lead you to your Revenue. 

4. Non- Financial Drivers 

This one is especially relevant to start-ups with social impact missions. ESG investment is on the rise, and if you can use numbers to demonstrate how you’re driving social change, the right investor may value this over cash-based figures. (Click the link for more guidance on how to turn your social impact mission into KPIs). 

Another tool you can use to help you is Relative Valuation. Look at other businesses in your market with similar models and offerings – especially listed companies, or those who have recently fundraised (you can find this information on sites like Seedrs). What are they valued at, and how was this number reached? Let’s break this down…

How Are Listed Companies Valued?

Let’s walk through some examples of listed company valuations, all in different markets and stages of their business journey. 

  1. Deliveroo

Deliveroo’s software-enabled service model made it a high-growth company in the UK and Europe, with an emphasis on LTV:CAC ratios (Lifetime Value:Customer Acquisition Cost). 

Deliveroo’s CAC per user is low, but if we base the LTV on £5 per month, it would be £5 over 12 months – £60 a year.  Let’s say the average customer is expected to last ten years. This gives us £600 LTV per customer. Multiply this by 6 million, and that’s £3.6bn of value. Based on projected price adjustments and client base growth, a $7bn valuation doesn’t appear quite so unreasonable.

  1. Oatly

An on-trend mission to stop reliance on dairy farms through an oat-based milk product gave this company a strong Environmental, Social and Government selling point. 

Oatly actually kicked off 2021 with a higher valuation. This was based on future pricing potential – coupled with celebrity investor hype – that sadly failed to materialise. Competitors quickly crowded the market with rice, soy, and nut based alternatives to milk, which negatively impacted Oatly’s valuation. 

  1. Coca-Cola 

A classic giant in its space, Coca-Cola is a stable business that generates recurring returns. But what about future growth potential?

Stable businesses are valued at a lower revenue multiple rate than high-growth companies who might be bringing in less. Why? It all comes down to future growth potential. Investors want to see a clear increase in ROI over time. If growth is stagnant, this is less likely to occur. 

Now that we’ve looked at how listed businesses are valued, let’s move on to start-ups. 

How Are Start-Ups Valued?

Start-ups use valuations to attract investors and raise capital for different growth stages. Let’s zoom in on three different start-ups that Addition has helped to fundraise successfully. 

  1. An Alcoholic Drinks Company

This food and beverage sector start-up fundraised through Seedrs in January 2022. They were working to reach the ‘Scaling’ stage, and needed cash to put into marketing and new product development.

We asked them to figure out how much cash they needed to run the business for 12-18 months. Our next question was how much equity were they willing to part with, and was it enough to appeal to investors in their market?

The result was a successful raise, out-performing the target, which provided a runway to develop their proposition even further. 

  1. A Brick and Mortar Company

A Premium gym company wanted to expand into new sites, as well as create a new offering. 

To support their fundraising, Addition built them a 3-statement model (Income Statement, Balance Sheet and Cash Flow Statement). We then looked to Crunchbase for recent raise examples from similar businesses, based on EBITDA and Revenue multiples. 

This gave them a ballpark figure to help with valuation. 

  1. A Tech Recycling Company

This start-up had ESG appeal, but was also generating revenue – making it an ideal fit for the right investor. We set about facilitating this with a two-step process. 

First, we created a P&L and Cash Flow model based around the number of recycling units they were projected to sell, as well as how many contracts they would secure. We then built a comparison chart involving listed and higher profile companies with similar business models to help justify their valuation. 

Armed with this knowledge, the founders were able to approach companies already investing in these other businesses, showcase the ways that they were outperforming the competition, and successfully ask for investment. 

Hopefully these examples have given you a clearer picture of how listed companies and start-ups are approaching valuation. Next, let’s check out examples of common pitfalls to avoid during your valuation process. 

What Are Some Common Valuation Mistakes?

  1. Unrealistic growth projections

Future growth is the whole premise of a valuation. The whole point of a financial plan is to provide you with a starting point. From there, it’s all about negotiating. Having realistic growth expectations lets you set the parameters of how much you actually need, and the percentage you should give away.

  1. Failure to show profitability

You may not be generating huge amounts of revenue now. But if you can’t show people you’ll be profitable in the future (even if it’s 5 years from now), why would they invest?

  1. Missing costs

Don’t forget to factor in all your costs – like taxes, production overheads, wages, leaseholds, annual subscriptions and licence fees. 

  1. Getting the unit economics wrong

You need to be selling £10 notes for £20, not the other way around. If your product costs more to deliver than it does to purchase, you’ve got yourself a problem.

  1. Not allowing for impact of debt

If you’ve taken out any business loans or money from the government that needs repaying, this will impact your future profits. Make sure you factor repayments (including any potential interest rate rises) into your projections. 

  1. Incorrect discount/risk factor

Money in the future isn’t the same as money today. When you’re working out future revenue multiples, you need to allow for rising costs, inflation, and other potential risk factors.

What To Include In Your Pitch Deck

Now you’ve applied your valuation principles, checked out benchmarks from other companies and made a note of issues to avoid – it’s time to build your pitch deck!

The above list should give you an idea of things to include in your pitch deck alongside your valuation. It should establish milestones and timelines, the cash needed to reach those targets and keep things running, as well as next steps for your business. 

Mentioning existing investors (such as anchor investors ) or any advisory boards you’re consulting will give your credibility a boost – so be sure to include them if you can. 

Some Weird And Wonderful Terms

To value your company and pitch to investors means entering the fundraising world – and learning the language while you’re at it. Doing the maths is one thing, but some of the terminology can make your head spin! Here’s a list of must-know phrases, along with what they mean for you.

  1. Pre/Post Money

This describes how much your startup is worth before and after investment – and it’s important for shareholders. For example, if your business is valued at £5m and you’re seeking a £1m investment, your business will be worth £6m once you get it. Your investor would now receive 1/6th of a share – not 1/5th.  

  1. Drag and tag/Share Subscription 

A share subscription is where shareholder rights are clearly defined. Drag and Tag means that if the majority of shareholders vote one way, the rest get ‘dragged’ along. This actually appeals to many investors, who have other commitments, as it means minimal involvement in the decision-making process.

  1. Discounted Cash Flow

We touched on this one earlier in the guide. DCF is a valuation method based on future cash flows, outgoings and increasing costs. 

  1. Sensitivity Analysis

Sensitising your business plan is all about being prepared for various scenarios. Have base, target and stretch plans to show investors you’ve covered every angle.  At Addition, we often sensitise plans by 25%-50% due to delivery risk and market uncertainty. The key is to underpromise and overdeliver – so you have a plan B in your pocket.

  1. Net Present Value 

Net Present Value is all about trying to bring future value back to today by taking inflation into account. List your current value, alongside what that same amount will be worth in the future. 

  1. WAAC

This is about comparing and contrasting yourself with similar businesses in terms of ROI. It’s looking at what shareholders and lenders will expect in return for capital, and making sure your offer can compete. For start-ups, a WAAC of 25% is often standard. 

In Summary

It takes time to build a business. Oatly was founded in 1994, Gymshark in 2012, and Tesla in 2003. You may see the wild valuations of early-stage business in the US and feel discouraged, but the more diligent approach in the UK will ensure that your investors – and you – won’t end up getting short-changed. While you’re here, why not use Seedrs’ Startup Valuation Calculator to value your company.

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Addition helps businesses from a wide range of sectors accurately value their companies and get traction from investors. Why not join the 200 SMEs making use of our expertise and give them a call?