Spoiler Alert: Valuation is more of an art than an exact science. Both quantitative and qualitative factors are used to inform and arrive at an estimated valuation. The latter typically carries more weight for earlier stage businesses as you have less quantitative data points on which to base a valuation e.g. external sales, profit, users etc.

This article focuses on the early-stage valuation of pre-revenue / early revenue businesses looking to secure angel / institutional funding. It seeks to explain how an early-stage investor may look to determine your company’s valuation.

As a founder, your view on valuation will differ from that of an investor. Typically, you are looking to maximise your valuation as this equals less dilution. Conversely, investors are often looking for a lower valuation as this equates to a higher potential Return on Investment (“ROI”) at exit.

Company Valuation

Quantitative and Qualitative indicators that can inform / drive valuation

  • Target Market
    • What is the size of your addressable market? Is this growing? Are you in a “hot / trending” sector? The larger the addressable market the more exciting the proposition
    • Is your idea a solution to a regional or global problem? Again latter is more exciting
    • Demand / supply dynamics: are you targeting a market that is already saturated with solutions to your customer’s points of pain?
    • Why will you win vs status quo/rivals?
  • The Team
    • Do you have:
      • a history of entrepreneurship and successful exits?
      • the relevant domain experience?
      • the relationships with the end target market and/or supply-side market?
      • the right skillset to succeed? If a skills gap exists, what is the plan to close it?
      • Are the team committed and aligned to deliver the grand vision? Personal investment (time invested or £ notes) and/or share options helps demonstrate this
      • Do you have an advisory board with domain experience at a c-suite level within large corporates/industry / academic bodies?
  • Market Traction
    • Proof of Concept
      • Can you evidence your concept can be developed? i.e. is the idea viable
      • What customer pain points are you targeting/addressing?
    • Minimum Viable Product (“MVP”)
      • Do you have a working prototype / MVP?
      • What are the core functionality and value proposition?
      • Have customers directly engaged with the MVP? Or can you evidence engagement with your target customer to help validate product/market fit?
    • Strategic partnerships
      • Have you secured any alliances with large corporates, industry bodies, academic institutions to help independently validate your proposition?
  • Defensibility
    • Is your solution patent protected?
    • What prevents it from being easily replicated by competition?
  • Financials
    • Expected margins? The higher the margin, the more attractive
    • Scalability of the proposition
    • Is the proposition scalable?
    • Expected scale-up metrics – CAC, LTV, Churn etc.
    • Is your scale-up plan credible? What evidence do you have to support the scale-up model?

Techniques an investor can deploy to appraise their return

Ultimately, an investor is targeting a specified return from each investment. The required return depends on the type of investor you target. For simplicity let’s split it into two cohorts:

  • Angel type investors (SEIS / EIS funds) – typically looking to return 15 – 20+% IRR across their portfolio of investments. Within the portfolio there will be winners & losers, this means new investments need to have the potential to deliver in excess of this – say 20+% IRR and 3+x return (before tax reliefs, which enhance returns)
  • Early-stage Venture Capital – typically looking to back potential unicorns. These businesses if successful could yield a “fund returner”. Say a VC’s fund is £50mn – your business has to offer a potential return to the VC of £50+mn to be a viable investment prospect. Clearly, VC type returns are only suitable for companies targeting large addressable markets and that can scale at pace

Consider which camp your business lies as this should directly inform the types of investor you target!

Company Valuation

Understand the Potential Exit

An investor needs to understand what a hypothetical exit may look like – this helps them appraise your valuation and determine the equity stake they require to achieve their targeted returns.

Further, given early-stage ventures are inherently high risk, investors often have a minimum equity stake they require to ensure they have a meaningful interest in the business to weather downside scenarios (i.e. it takes longer and more money).

How do they arrive at this / what factors do they consider?

  • Develop an understanding of the metric(s) which drive valuations in your sector e.g. revenue, EBITDA, users #’s, data / transaction volumes etc. Comparable exit / investment transactions are used for this. If you are pioneer, then they may look for other successful exits in parallel markets as a reasonable proxy
  • Understand the estimated funding quantum required between now and exit. This is critical – if the investor is unable to follow their money or opts not to follow in full, future funding rounds will dilute their shareholding and ultimately reduce their exit proceeds
  • Understand what the potential buyer pool may look like and their associated acqusition thesis. Strategic acquisitions typically command higher exit values vs bolt-on “more or the same” type deals
  • Understand an estimate of what your business would look like at the point exit e.g. revenue, EBITDA, users, data/transaction volumes etc.
  • Using the former intel, and factoring in downside scenarios (i.e. it takes longer, needs more money etc) they estimate a range of exit values – this informs their assessment of the required equity stake on day 1.

Jonathan Griffiths

Director, Corporate Finance

If you have any questions on the above or would like to discuss your upcoming equity funding raising round email entrepreneur@chiene.co.uk. Further information/creds on us can be found here.