Valuation from the angel perspective
To define the pre-money valuation of your company is tricky and there are no correct and true answers to the question of what your valuation is. Be prepared to discuss the valuation when negotiating the funding round with the angel investors.
There is obviously no right answer to the question "What is the company valuation". As a rule there will be negotiations between the entrepreneur and the investor regarding the valuation. Sometimes it leads to a “discount”, sometimes not. The whole discussion might be “postponed”, for example by giving the company a convertible loan and setting the price to depend on some metrics, like sales or profitability.
A business angel is bound to look for returns that are bigger than most markets (like for example the stock market), because of the big risks involved with angel investing. The entrepreneur needs to define the value of the company before new shares are sold to a business angel, i.e. the pre-money valuation. The pre-money valuation is needed in order to be able to say how big a share of the company is offered for the investment the angel investor is about to make. An average Finnish business angels invests 25 000 euro per company and expects an annual return of 20 percent. The average time needed to develop the company and be able to sell the shares further is 8 years.
FiBAN's business angel member Sami Etula has created a valuation tool combining 17 of the main calculation models to define a company valuation. The tool can be used as a guideline to open discussions. The same can be done with the tool FiBAN member Esa Mäkeläinen has created with Valuatum. There are several tools a company can use to get guidance and perspective to their valuation. No tool will of course be able to replace negotiations.
Calculating valuation demands
This model is created to help you help understand what a certain valuation demands, i.e. how much sales and how big a sales margin is needed to increase the value of the company taking into account the demanded return during and the whole timespan of the investment.
A too big valuation makes it impossible to reach a reasonable rate of return and therefore destroys the risk and return balance. Most startups do also need several rounds of financing. The risk of having to go down in valuation in a following funding round increases if the valuation is too high during the first round. That has a negative effect on the odds of receiving future financing.
We recommend a valuation that can be supported by the sales numbers, as is usual for all companies. Sooner or later any company will be valued on the basis of it’s profitability.
The purpose of the following model is to provide an indicative valuation of the startup looking for angel funding.
This model provides a possibility for the entrepreneur to look at how the:
Here the key components and inputs of the model are next briefly explained:
Due to the the nature of early-stage investment, discounting effect and terminal value are excluded from the model. This is due to it is not overall possible to estimate if the company will succeed further with time or not.
This model is an estimate and gives an indication of your valuation. We acknowledge that there are different ways of determining the valuation of a startup. The valuation of a startup will always be an important discussion topic during investment discussions – so be prepared to alter your valuation.
What is the value of a company?
FiBAN’s study suggests that slightly over 50 % of the financed companies got the valuation they asked for, while the rest received financing at a lower valuation. The average discount was close to 30 %. This is however not the whole truth. It is likely that some of the companies received less money than they asked for – but to their original valuation – because of the investor’s decreased interest. The investor might plan to later invest more in a consequent round with more facts at hand.
More importantly, a great number of deals never take place because no agreement can be reached on valuation. It is rarely worth going into discussions if the entrepreneur’s valuation is, say, five times what the investor thinks it should be. Those cases are simply rejected (and thus not in the statistics). A study, Equity financing of early stage growth firms in Skåne by Karl Fogelström and Christoffer Nilsson, also says “the most common reason why angels did not invest, was because they found the valuation of the company to be too high”. The highest possible overpricing without frighten away investors, seems to be around the double what investors are ready to pay. This is supported by the results of our study, where the highest “discount” was 57 %, and a few others were around 50 %. In other words, do not play yourself out with overpricing your good idea! It is better to receive financing at a lower valuation than to lose time – or be out. In the best case, you might be dragged in to an auction between many interested investors, but that is only the case for the absolutely most interesting companies. For most startups, getting funding is hard, and a bona fide offer would usually be worth taking.
Back to the beginning and the basic question, how to define the value? It does not make it any easier that we are mainly talking about pre-revenue startups. No traditional cash flow or balance analysis is applicable. It is always a negotiation. If there is no “buyer”, the price is too high. There is although almost always a “right price”, just go out and find it. A smaller share of a company with possibilities to operate is better than a whole company that lacks the resources to operate.
Valuation is discussed at several of FiBAN's business angel trainings found from FiBAN's event calendar. We highly recommend business angel academy (In Finnish) which focused on valuation.
Please contact FiBAN administration for any comments or feedback.