Whether you’re 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, or a full understanding of the value of any minority stake given away.
However, valuing an early-stage business is rarely a pure science. As Seedrs’ go into further detail in their resource The Art of Startup Valuation, 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.
So, how can you maximise and substantiate the valuation of your startup? At Smith & Williamson, we have an established Transactions department that is dedicated to advising companies through all phases of the business lifecycle, and we believe that there are six key areas founders can drive value.
1. A Focus on People
The lifeblood of your startup is your team. The principal 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.
Investors are looking to see the following: your startup has the necessary experience to deliver what you’ve set out to do; your team have the insight to identify their own weaknesses and hire talent to complement them, and your team can constructively tackle all of the many challenges that are occurring (and will occur) during the lifecycle of your company. So, ensure you can demonstrate (or defend) the following attributes:
- Technical or commercial competency to achieve the vision of your startup through direct experience, or development of relevant skills.
- Capability to settle conflicts swiftly and constructively. Although some investors implement an artificial ‘stress tests’ during investment reviews, this isn’t standard practice as investors can generally pick up on potential internal personality issues just from spending time with the team.
- Comprehension of the key assumptions and metrics of the market you operate in, as well as how to measure the performance of your startup within the market.
- The geographical spread of your team. Obviously, the internet has revolutionised the way we communicate, but some investors could be concerned about the ways a lack of proximity can affect the dynamics of your team.
- The equity spread between founders. Generally, the founder equity split is equal (e.g. 50/50, 33/33/33), but if there’s an imbalance that could signal to an investor that a key hire or co-founder might feel unmotivated later down the line.
2. Running an Effective Fundraising or Exit 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 your management team as competent and organised. An effective transaction process will encourage competitive tension between bidders and put you in a strong negotiating position with potential investors.
3. A Strategic Plan for Exit
Even when you’re not planning it in the short-term, preparing as if that’s what you have in mind will support the value of the business in the long-term. It means you are always building a track record, rather than retro-fitting one when the time comes to sell.
Early-stage investors gauge what the likely exit size will be for a company of your type, and within the industry in which you play, and then judge how much equity their fund should have in your company to reach their ROI goal. So it’s a good idea to include a projection for roughly when and how you will exit the company in your investment pitch deck, for example, a software company may project their strategic plan to gear them up to a trade sale in 5-7 years. Even when you’re pitching for your early rounds of investment, the exit strategy should have a key place in your pitch. If you’re looking for a template on how to put your pitch together, check out the Seedrs investment pitch deck template here
4. Good Housekeeping
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 places the founder on the front foot. That means developing a business plan and a track record, rather than retro-fitting one later down the line. Operationally, it also means implementing sound financial policies, management oversight and compliance, and ensuring the proper treatment of customers and suppliers.
Remember due diligence works both ways, much as an investor will do their due diligence on your business, it’s worth you doing your due diligence on investors.
5. Building and Leveraging Intangible Assets
Most early-stage businesses will need to think about ways to increase their presence in the market and communicate that to investors. Growth potential is often predicated on the ability of the business to influence customer behaviour and, for discretionary purchases, one highly valuable intangible asset is your brand. For example, the award-winning winemaker and craft brewer Chapel Down created new brand assets ahead of their crowdfunding campaign on Seedrs in 2014. By creating a strong brand identity – a timelessly stylish, sophisticated and high-end company – they successfully appealed to high-end investors through assets such as a 60pp, perfect bound share offer document and highly visual adverts used in national print and varying outdoor advertising.
6. Demonstrate Traction
Obviously, the best way to communicate traction is to demonstrate escalating revenues, which is not a luxury the majority of early-stage companies have. However, by finding other ways to express and articulate traction, it can go far to drive value for your startup.
For example, is your user growth gaining momentum? This can show a growing interest in your product. If you have a rising number of adoptions in your freemium offering, this can be an indication of potential future sales.
Any metrics you can provide to show investors that you have a product with an engaged community of early adopters, add them to your pitch. One of the benefits of Equity Crowdfunding is that a campaign can act as validation to investors if they can see a campaign gaining traction. A campaign supported by thousands of investors act as the answer to VC’s and Angels’ utmost question: “will people buy this product or service?”.
So, unlike external factors which are difficult to control, by influencing the above six areas, you can help maximise your startup’s valuation in the eyes of investors. By driving this value, you’ll be in an excellent position to negotiate with investors.