Note from Jimmy Hua:
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Determining your startup’s worth is one of the hardest parts of the fundraising process. There is no magic formula that will spit out a valuation, namely because the number is highly subjective. The entrepreneur, for example, anticipates huge potential and may therefore put a high valuation on his company. The investor, on the other hand sees a company that needs capital to grow and may fail without it, so he may set a low valuation. To help the process, we’ve devised a few considerations to help value your company.
1. What You Need
Before you set a valuation, you’ll need to calculate the money needed for both immediate and long-term success. Once you have identified the general range of capital that will help you maintain and grow, you can focus on other factors that determine your company’s worth.
No one likes to sacrifice a piece of his company, but there should be a range you feel comfortable offering up to potential investors. You need to find a balance though. Don’t give up too much and lose control of your company or dilute its value, but don’t be stingy either, thereby rendering your company unattractive to investors. Planning 10-20% equity for seed investments is a safe range for startups.
3. Intellectual Property
Having a lot of intellectual property could push up the valuation of your company. Your IP might be a patent, a copyright, a design or even a website code. If your IP will give you a competitive advantage, you should assign it a higher value. Look to other companies with similar IP and see what they placed as its value.
4. Other Assets
You may have purchased assets or created some other value while building your startup, for example, a domain name, servers, equipment or property. It is much easier to assign a value to a tangible asset, but be sure not to overlook intangibles when adding up the overall value.
5. Barrier to Entry
You need to consider the time it would take for someone to copy your idea. Simple ideas often have low barriers to entry; they’ll have to fight off “me-too” companies very quickly – for example, Groupon and other “deal of the day” sites. Startups with high barriers to entry present complex ideas that may require a lot of time, money and effort, and therefore face less competition. However, high barrier to entry (longer first-to-market exclusivity) may be more attractive, and therefore more valuable, to potential investors.
6. Future Value
Estimating the value of your company’s future potential is probably the hardest and most subjective step, especially when it’s only at seed stage level. The momentum enjoyed by late-stage companies shows future growth potential, but early-stage startups have less tangible results and fewer concrete scenarios for success. It is important to not underestimate the potential value, however, by presenting enough data to back up your valuation. A solid business plan and avenues for growth will solidify your valuation to potential investors.
Investors like to see traction. They’ll be more willing to sign a check when they can see that others have used your product or service. If you have customers, calculate a lifetime value for each, and factor that figure into your overall valuation. As an early-stage company, you may wish to provide free services in order to gain traction, and then use it as a means to increase your company value.
Have you or your business concept been mentioned in the press? Has your concept gained recognition for its uniqueness or its cool factor? Is that coverage bringing in unsolicited potential investors who are interested in your company? Use this as part of the valuation. Again, dollar amount is subjective, but the fact that people are seeking you out should push your valuation higher.
Just like every other commodity, valuation relates to supply and demand. If your concept is new, first-to-market and fills a customer need, you can raise the valuation. Alternatively, if the market is depressed or saturated with similar, established products, investors might foresee a lower valuation for your company. The market constantly changes, however, so watch the landscape for an appropriate time to raise capital. It may mean shifting your product, concept or target market, but if the tweak allows for a higher valuation, it may be worth it.
By using these components as a starting point in determining your startup valuation, you’ll be closer to a more accurate number, one an investor views as fair and equitable. It’s important to clearly outline the reasons your company is worth what you’re pitching to potential investors. Your confidence will go far by building their trust in your leadership and your ultimate business success.
Image courtesy of iStockphoto, Mario13
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- 10 Ways to Size Your Company’s Value for Funding (startupprofessionals.com)
- How To Know Your Side Project Is Ready To Be A Startup (jimmyhua.com)