How to Increase Your Startup ValuationGuides
How to Increase Your Startup Valuation

Whether you are looking to raise finance or eventually exit, a sound understanding of the value of your business is a vital starting point. It allows for a proper appraisal of the terms of any offer, whether that be for a minority stake or the entire business. But how do you ensure a good valuation for your business?

Valuing an early-stage business is not straightforward. Often, these businesses are seeking to exploit a new concept or technology which is relatively untested in the market. For the time being, the business may be sub-scale with low revenues and a high cash burn rate.

This means the usual valuation techniques routinely used for larger businesses may be difficult to apply. For example, applying a valuation based on multiples of earnings to businesses which are loss-making or which have low but fast-growing revenues can often be challenging. Discounted cash flow may also be difficult to apply since the company has yet to prove itself in the market and may have negative cash flow and insufficient trading history from which to draw meaningful conclusions.

Equally, where a company is genuinely innovative and breaking new ground, there is an art to selecting comparable companies and applying suitable adjustments to reflect differences between it and the more established incumbents.

Valuing an early-stage business is almost never a pure science. There is often a tussle between founder expectations and those of investors. On the one hand, the founders must be confident in their ideas. Otherwise, why would they be doing it? On the other hand, professional investors may have a more sceptical outlook. In some cases, they will be institutional investors with fiduciary duties. In almost all cases, they will be looking at the risk as much as the reward.

At Smith & Williamson, we have an established Transactions department which is dedicated to advising companies through all phases of the business lifecycle. For early-stage businesses, we believe there are four drivers of value:

  1. A focus on people – The value of an early-stage business lies in its potential and how that potential is brought to life. That means investors are not only looking at the addressable market, but also the team’s execution capabilities. It is not uncommon that the product or service requires further development. Far more important today is the team’s skill in improving and adapting to the changing needs of the market. Any investor will want to see that key staff are incentivised to stay and grow the business. Competition for talent is fierce, so a culture which attracts and retains gifted people is vitally important. Are there tax efficient share schemes or share options in place to align the interests of the team with that of the organisation?
  2. Building intangible assets – Most early-stage businesses will need to think about ways to increase their presence in the market. Growth potential is often predicated on the ability of the business to influence customer behaviour and, for discretionary purchases, much of that revolves around the brand image. Coca-Cola can sell at a premium price whether people can truly taste the difference or not. For companies selling B2B, it comes down to the quality of the client relationships. And where technology is critical to the business, founders need to think not only about how much has been invested to develop it but also the excess earnings they can generate through monetising it effectively.
  3. Strategic planning – Even when existing shareholders are not planning a major transaction event in the short-term, preparing as though that’s what you have in mind will support the value of the business in the long-term. When the time eventually comes, business owners need to be prepared for a thorough due diligence process because investors certainly will. Continually assessing the strategy can help identify and address any gaps ahead of time and puts the founder on the front foot. That means developing a business plan and a track record, rather than retro-fitting one when the time comes. Operationally, it also means implementing sound financial policies, management oversight and compliance, and ensuring the proper treatment of customers and suppliers.
  4. Running an effective transaction process – When it comes to a fundraising or exit event, founders can drive value through the deal process itself. That means doing the work up-front to establish value expectations for the business and identify likely investors. Pitching at the right level is vitally important in helping to present the management team as competent and organised. An effective transaction process will encourage competitive tension between bidders and put the business in a strong negotiating position with potential investors.

Most successful early-stage businesses will excel in at least one of these categories. Unlike external factors which are difficult to control, founders are increasingly recognising the influence they can have in these four areas when seeking to gain a competitive advantage and drive value.

Digital Agency Kent