Five Key Points to Consider When Valuing Your Early Stage Company

How much is your company worth?  Your answer to this question will directly impact your ability to raise capital.  An owner would be wise to educate him/her self on the topic of valuation prior to pitching potential investors.  Here are five points to consider.

•         There is no direct correlation between how much capital you have injected into your company and your current valuation.  Unfortunately, we frequently hear this justification for lofty valuations.  I don’t know a single investor (founder or outsider) who wants to believe their company is worth less than the amount of capital they have invested, but often it’s the truth.  If you make the argument that your company is worth “x” or “x+y” because that is the amount of capital invested in building the business be prepared for potential investors to walk, simply because they perceive you as naïve.
•          Let’s face it, if you are a pre-revenue company, one could make a compelling argument that the asset (the company in question) has little or no value.  Liquidity is a key element when determining valuation, and securities in pre-revenue companies are highly illiquid.
•          You’re intellectual property is, more than likely, worth less than you think.  Intellectual property only has value if it’s being monetized, whether by the company that owns it or a competitor.  Here’s the rub, a patent is, more or less, only an invitation to court.  Intellectual property litigation is expensive and time consuming.  Even in a scenario where a competitor is able to monetize a company’s intellectual property, unless that company has the resources to pursue legal action and recoup damages, their intellectual property might as well be used as wallpaper.    
•          Google and Facebook success stories are events that happen once, maybe twice, every decade.  Please, stop justifying your outlandish valuation by comparing your company to either.  You may be entering a huge market, with a great product or service, and a seasoned management team, but justifying your company’s value by making these comparisons is not only ridiculous, it’s hilarious.
•          If you are not producing revenue, you do not have earnings.  All tried and true valuation methods used for determining the value of a going concern, outside of the start-up markets, are hinged on a company’s earnings.  You do not have a leg to stand on if you use DCF (Discounted Cash Flow) analysis to value your company, when the financial data used is solely projected.  A lack of earnings does not automatically imply that a company is valueless, but we’ve never seen a pre-revenue company accurately project their earnings over the following year, let alone five.

Using an outlandish valuation figure is one of the quickest ways to kill a deal before it’s even begun, because it’s proof to any investor they are dealing with an amateur.  Amateurs tend to be costly to investors, and investors hate funding learning curves.  Determining the value of an early stage company is incredibly subjective.  Value is not derived solely from current earnings, asset base, intellectual property, etc; value is derived from a combination of these things.  How well positioned is the company in the marketplace?  Does the company have intellectual property?  How is it protected?  Who is the management team?  What are their backgrounds?  Do we believe in them?  Are there earnings?  What are the potential earnings?

At the end of the day, when it comes to raising capital, a company’s value will be determined by leverage; and, leverage will come from how many investors want in on a deal.  The result of having multiple parties who want to play ball is the ability to negotiate a better deal structure, and hence a higher valuation.