Yaro Blog

How To Value Your Startup Company When Looking For Investment

This was a post I wrote about regarding the process of looking for funding for CrankyAds.

This has been a completely new experience for me, which is fantastic, I’m enjoying the challenge and the process of learning how another aspect of entrepreneurship works.

I’ve been attending networking events and putting my feelers out in Brisbane where I live for a while, which thankfully has been relatively easy because of the currently booming startup industry in Australia.

I’m looking for people with money to invest, but more recently I’ve been looking for people to learn from first, people who have taken investment or who advise businesses or help them through the investment process. I know when I am lacking in information and this is definitely an area I needed to learn more about, so I’ve had a lot of conversations.

Three Very Different Points Of View

Last week we had three interesting meetings with various people. My business partner Walter and I met with one guy who is behind a very well funded tech startup in Brisbane, who has raised millions for his company both in Australia and overseas. We also met with a friend who sold his hosting company for millions to overseas buyers, who also took funding along the way, and another gentlemen who has years of experience in the tech industry and currently advises investors and invests himself.

What was particularly interesting about these three meetings were the very different points of view.

One of the key questions we have faced is how to value a company, especially when it’s not profitable yet, so we know how much equity to distribute and how much money we can raise in return.

We all know what happened during the dot com boom of the late nineties, with so many companies living off investment capital, focusing more on user acquisition and a potential float on the stock market or buyout as an exist strategy, ignoring business fundamentals like a profitable revenue model.

Some people are saying we are going through another similar period now, especially after the recent acquisition of Instagram by Facebook for a billion dollars, even though Instagram does not have a revenue model or makes a profit. I don’t think we are quite back to where we were, but there is definitely a peak in interest in tech startups again, and some pretty crazy evaluations occurring for companies that have yet to prove they are going to make money.

Here’s a breakdown of what I learned from the meetings, in particular with regards to how to value a company during the startup capital raising period.

Option 1: You Are Worth As Much As Your Potential

My week of advice meetings began at the offices of a new tech startup in Brisbane, which has raised several rounds of funding and is following an investment model similar to many silicon valley startups. While I don’t know the specific numbers of this company, I know they are not getting investors based on profits – it’s coming in because of the hype behind the industry and the potential to be the next instagram story.

The idea here is that you can “value” your company, even during an early startup phase, based on the potential you have in your market. To do this, you look to similar companies in your industry and what sort of valuations they have today.

You can take this as far as you want to (or are at least confident – or audacious enough to try), valuing your profitless company in the multiple millions, even hundreds of millions in some cases, when all you have is a business idea and possibly not even a working prototype. Obviously you have to actually convince others of the potential and your company’s worth, but if you can, then accessing millions in investment funds without giving too much equity away is a real possibility.

This option is all about your potential and your growth rate, not so much your profit and loss statement. If you can show growth and the potential for a big buyout, then raising millions today is a possibility, given you find the right investors willing to take a shot at your idea. When I say “take a shot” it really is just that – your investors are basically gambling on you and your idea, without needing to see that you make money or cover your costs with cash flow, or any similar sound business principles.

Option 2: Go It Alone Until You Have Results

My second meeting was with a tech orientated entrepreneur who had successfully grown a hosting business and exited with a multimillion dollar pay day. This person was more developer than entrepreneur and his work ethic definitely influenced the kind of advice he gave us.

He essentially told us to put in 100 hour weeks ourselves and not take on investment if we can get away without it. If you can make it work with pure manpower then you won’t have to worry about “wasting time” preparing presentations and documents to secure funding, attending meetings, etc – which all distract you from actually working on your business.

This also means you are not “suffering” from the whims of an investor, who wants to know how his or her money is being spent, how you are doing or who tries to influence how your business is managed (which in some cases is certainly what an investor should be entitled to do).

I like this principle. I like it a lot. I’ve pretty much spent my entire entrepreneur life to this point following it (perhaps not the 100 hour working week part) since I have self funded everything I have ever done. It actually made me realize how lucky I was to climb a success ladder and enjoy the rewards of simple business models over the previous years.

Of course this advice isn’t always applicable or everyone would avoid investment and just go it alone. It depends on the magnitude of resources required and what’s currently available to you. If the deficit is too great and you simply can’t reach a point where you are self sustained without some kind of bridging capital, then you have to seek investors. It’s no coincidence that the largest companies have usually required capital injections as they have grown.

Option 3: Raise What You Actually Need

In a wonderful piece of symmetry, our third meeting with an investment advisor and investor himself, offered a more middle of the road path compared to the two opposite ends of the investment advice spectrum we had received so far.

After a three hour discussion with this experienced mentor, where we broke down our business idea in detail, talked about our options regarding investment and cut to the chase about the most important questions to answer, I felt we finally had a solid base from which to make a decision.

The advice given in this situation was to be realistic but to also prepare for the future. Don’t go for pie in the sky valuations unless you can truly back them up with growth potential and are prepared to ride that roller coaster. If you need funding, get clear on why you need the funding and how you will spend it. If you can be specific, investors are more willing to trust your projections.

The advice basically came down to at least testing your idea and getting a few runs on the board. Enough that you can begin showing potential investors you have something that, given some investment, could grow and meet expectations because it already has results. This is important when it comes to a potential return for the investor, one of the most important decision points for any person who is going to give you money – they need to see that your idea works, it’s tested, and they will earn a return on their money.

In terms of how you value your company, if you can show income, and ideally cover your running costs, then you are in a good position. From there, you can use your current numbers as a base, and do some projections. In this case instead of using potential based on how other companies are going, you can multiply what your numbers already show. This way your potential is based on what you are actually doing, not what you think you can do based on how other companies have gone.

This is a bit more of a down to earth method of valuing your potential for success. I don’t know about you, but I feel better asking for money to help grow my business when I have already seen that my business can work and I just need the money to make it bigger. I can then show people, for example, if instead of having 100 customers that we have today, we have 1,000 in 12 months and will be making X dollars, it is more justifiable to ask for a certain amount of money in investment – you have some sound benchmarks that make sense and are tied in with revenues returned to the company.

Think About The Future

One of the best tips we walked away from the meetings was to treat our initial funding round as a stepping stone to more significant funding when we really want to ramp up growth. While this isn’t necessarily something you have to do (and to be honest we would prefer to become self-sustained sooner rather than later), it did highlight the need to think long term.

The money we need now helps us to develop the technology and test the model, but once that is done, in order to really expand, build out the features and market extensively (and hire all the people to do these jobs), you may need to ask for $3 million or $5 million or even $10 million and beyond.

When you reach this point you are already successful, you have a working business and things are growing. The idea is that funding helps you go from that 100,000 users to 1,000,000 users, or a similar significant stepping stone. Or you might need it to build out the advanced features of your technology, which is something we have considered for CrankyAds as we have a staged development plan that, assuming the first two stages go well, will require us to develop some clever technology and some clever – and well paid – people to work on it.

So How Much Should You Raise?

The best advice I can give you, and what I concluded after this week of initial personal meetings, is the following –

  • Consider how much money you actually need and GET SPECIFIC. If you are using the money to pay staff, do the math on salaries. The same goes for your technology costs, legal, accounting, customer service and rent. If you can itemise and value everything you are going to need, then you have a clear path and a clear number in required funds.
  • Be realistic about what you think your company is worth today and what it will be next year, the year after and the year after that. If you are playing the game of user acquisition numbers and potential big buyouts, then be upfront about it and be prepared to play that game. You will need to find the right type of investor who is willing to take a gamble on your potential, rather than your cash flow (which may not exist yet).
  • Personality plays a huge part in all of this. What I noticed was that each person we met had a personality that matched the way they gave us advice. Take this into account given your personality. Do you have the belief to tell people what you are doing now is worth $40 million today even though you haven’t made a penny of profit yet? Or on the other end of the spectrum, perhaps having any investor telling you what to do and having the responsibility of spending someone else’s money just doesn’t sit well with you, but working 100 hour weeks without investment is something you are prepared to do so you don’t need funding?
  • Consider where you are on the growth curve. The easier it is to demonstrate your potential showing actual results, the easier it will be to convince people to invest in you. The more you grow on your own, the less you have to give away (in equity) when it comes time to take investors on, and the more money you can raise.
  • Learn what investors want. Based on repeated conversations, the most important variables are:1. Your team – especially having a tech person as a co-founder, but also a CEO for doing things like presentations (tech people aren’t always great at the more social aspects of business), and if possible, a financial person, like an initial investor with street cred in your industry to help sway more investors to jump on board (social proof in action).2. What you need the money for exactly (remember SPECIFICS!)3. Your potential for growth (market size) and where you are on the growth curve now4. What results you have achieved so far (are you cash flow positive?)5. And of course, the idea itself!

That’s a summary of what I have concluded thus far. There are many other areas I have talked about with plenty of smart people, and I plan to have many more conversations, but I can say thanks to these initial conversations I feel a lot clearer about what we will be asking for with CrankyAds.

Hopefully I have helped you become a little bit clearer too.

Yaro
Raising Funds

Photo courtesy of SeedRocket_

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