Some Brief Thoughts About Valuation

Entrepreneurs sometimes feel like they have to do battle with investors over valuation. Many see it as a winner take all negotiation. It doesn’t have to be that way if you frame valuation in the right way. Valuation is essentially corporate finance. While money/equity/debt are involved, corporate finance is just another strategic tool in the entrepreneurs tool box. It’s a weapon that you and your investors can use to battle competition in the marketplace.

Here are some statistics that entrepreneurs should know about. Each year, roughly 600,000 companies are started in the US. Of those, 60,000 receive angel capital. Of that 60,000, only 1000 will receive venture capital each year. That’s a tough funnel and entrepreneurs need to arm themselves to get through it.

Value yourself too high, and the next round of financing may be difficult to get. Invariably, unforeseen problems come up in the life of any start up business. Those problems burn through working capital. If you raised the benchmark 12-18 month run rate of capital, the company ought to be able to weather the storm. But, it’s that next round that could be very difficult if your growth was flat, or worse, declined. Many a company has gone through the seed round of capital and died because of a lack of ability to raise the next round. Value yourself too low, and there won’t be enough equity to give employees incentive to grow. The company may have trouble attracting and keeping talent. The internal momentum of the company gets sapped. Investors may have to take on a lot of dilution in order to get the next round of capital. The economics behind growing the company aren’t there, and it dies. Instead of thinking about absolute numbers, think of building momentum. Each round of financing should build upon the last. Make sure each round of financing gives you a slightly higher valuation than the next, and that you have the metrics to prove out that valuation. This is especially critical in the first few rounds of investment. Each company is different and valuation isn’t an exact science. It all depends on the market you are attacking and how big your company can be. But getting initial valuation is important, because without the money you can’t get going. Without additional higher valuations in next rounds of investment, you will have trouble getting investors excited.
It’s always a shame when poorly designed corporate finance strategies doom a company. It’s tough enough to build a great company.

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