Deal breakers series: How do you value your Impact Start-up? Part 1/3 - Impakt tribe

Deal Breakers, we all know them and everybody dislikes them and wants to avoid them like the plague.

I’m amazed by the fact that many Entrepreneurs are still not well prepared while looking for an investor, I did in-depth research under our customers and investors regarding the deal breakers in the funding process. I have detected the 8 biggest deal breakers you cannot afford to ignore.
This is the first in a series of 11. Why 11? because the biggest deal breaker is how to value your company! As you probably already noticed, this is one of the hardest things as an entrepreneur, when raising a round of financing, is figuring out your valuation. It is a true brain cracker and pricing the company poorly can have a negative impact on future rounds of financings. It is even harder for Impact companies because you also need to look at other parameters. This is the first of a series of three blogs only about how to value your company.

Ok, here we go! have fun reading.

As an Entrepreneur, you are open to offering potential investors equity in your company, in other words, the Entrepreneur gives an investor the rights to own and control an asset or part of an asset and the entitlement to future cash flows generated from that asset.
So the question becomes “what asset does the company have to offer from which an investor (or someone else) can benefit?” How do you value that asset?
An asset is not an asset unless you are able to get a future benefit from it – generally an income stream or be able to sell it for more than the cost to create it. Capital gain or capital appreciation is derived again from the potential for future income stream or, in some cases, use value. The point is asset value, in most cases, means the potential to generate a recurring income stream from paying customers.

That goes for impact businesses and social ventures as well. If it is impact only and no income stream, then it is not suitable for social venture investment and instead is better suited for philanthropy. If the Company generates a blend of financial and impact returns, it becomes a more complex evaluation of asset value, which I will write about in the second part of this series of valuation and I will also give some examples of possible approaches, but there are no universally accepted methods of measurements and valuation.
According to my personal experience with the companies, we helped to raise capital and you have a quick growth rate down here is a quick guide you can use from what I am seeing in the market:

Pre-seed: raising €50K – €150K at a valuation of €250K – €500K
Seed: raising €250K – €1M at a valuation of €1M – €3M (revenues are €0 – €50K P.M.)
Series A: raising €1.5M- €6M at a valuation of €5M – €20M (revenues are €100K – €250K P.M)
Series B: raising €6M – €20M at a valuation of €15 – €50M (revenues are €350K – €800K P.M.)
Series C: raising over €20M at valuations of over €100M (revenues are over €1M P.M.)

In my opinion, the best way to establish a valuation is to see what the market is paying for some of your competitors when they were at your same financing stage. There are several sites that you can use to track such transactions. Using competitor valuations to establish your own makes it difficult for investors to tell you that your valuation is too high which is often a tactic used by investors to bring your price down in order to obtain more equity for their investment.

The most common ways to put a price tag on your business include the following methods:

The Discounted Cashflow Based valuation (DCF)

Revenue-based valuation

Users based valuation

Asset-Based Valuations such as the Book Value or the Liquidation value

Market & Transaction Comparable

Risk Factor Summation Method which compares 12 characteristics of the target company to what might be expected in a fundable seed/startup company.

As you find above, there is more than one way to value your startup. I will high light some of the above-mentioned methods to give you a better idea and pros and cons.

DCF;
This method requires the assessment of and trust in the ability of the existing team to execute their plan. It requires knowledge of the potential market and trust that the company will be able to gain market share. If you are a close friend or associate of the company or you have inside, specialized knowledge of the market or sector in which the company operates, you may be able to place confidence in projected cash flows. This is entirely dependent upon your comfort level.
The projected future cash flows must be discounted to today’s value. The discount rate would be in the range of 30% to 60%, maybe higher. The riskier the venture is and greater uncertainty around the projected revenues, the higher the discount rate.

Revenue Based;
As an investor, evaluate how long into the future those revenues could continue. Your risk is that customers will not return or that the customer pipeline does not get developed. There is a risk the team will fail to execute the plan. You would value the company based on a multiple (or fraction) of the annual revenues. High risk and the multiple would likely be 1x or less (1x meaning, the investor can only rely on 1 year’s worth of revenue to reliably continue). High potential would lift the multiple higher. The potential needs to be backed up by solid evidence and research, having spoken with real, live, potential customers.
User-based; if the company has a customer base that can be monetized
Evaluate what revenues could be generated from this valuable customer base by selling them other stuff or advertising. A lot of tech platforms like Facebook, Instagram, and Pinterest fall into this category. In the olden days (i.e. the 1990s!!!), people used to sell mailing lists. I had an audit client that made their business brokering mailing lists. It has value because you have an audience you can sell to. But you would still have to estimate the revenues that could be generated. The only way to get more confident about this is to ensure that the company “gets out of the building” and ask customers.

Asset-based;

The Company has patented or built asset or technology
If a revenue stream is non-existent and not apparent, consider whether revenues can be generated by the company’s team. If down the road, the company fails, can you get another team in to turn the asset or technology into a revenue-generating asset? There is high uncertainty around this.
You could evaluate the real, hard costs invested in building the patented technology and apply a big discount. Labour time and equivalent salaries may or may not be included (is their evidence of outcomes from that sweat equity? What asset was created from the time spent?) You might be willing to pay some amount of cents on the Euro, but it depends upon your evaluation or perception of the value. If you end up with technology that isn’t producing revenue, you will have to spend more time and money to find a way to make it generate revenue.

Comparable based;

Are there any comparable companies?
This can be a challenging approach if there are few comparable companies. How much have other similar businesses at a similar stage been valued at? Or how much is a similar business valued at now and discount it back a number of years.

Other Factors to Consider;

Investor control
As an investor, you are trying to mitigate risk and protect your investment. So if things go wrong and you are at risk of losing your money, what can you do? Can you incentivize the company’s team to take a different direction? Can you fire the Company’s team and replace them? Can you take control over the asset? Can you sell your share to someone else? Is it worth something to someone else? You may want 50% or 51% of the company, so you have control if things go bad. Or you might have a high degree of trust in the team and therefore happy with less than 50%.

There are only two things investor don’t like.

1. Losing their money

2.To be made look foolish

If the amount of the investment is a lot to you and the venture is high risk, you might want more control in the form of an influencing shareholding or at least triggers where you can step in and guide decisions and the direction of the business.

Where a founder retains control, like in the case of Facebook, the founder is inextricably linked to the business. There is an implication that Facebook doesn’t exist without Mark Zuckerberg and all investors accepted that. But they were convinced enough by the rate of users signing up that there was an asset to be mined.

Due diligence
Keep an open dialogue with the start-up company’s team and find out what their valuation expectations are. A final, agreed upon valuation number won’t be reached until after due diligence, but it is useful to gauge where expectations lie.

Other deal breakers
This is the first of a 3-part series on Valuing a Start-Up Company. The second part is all about pre-money valuation and which methods you are able to use to value your company.

The third part contemplates valuation of a blended-value start-up, in other words, a company that has a social mission embedded in their business model, aims to deliver positive social impact or change, or tracks itself based on a triple bottom line.

The more valuation models you use the more confident you can be that you have valued the business correctly.

Good luck with your valuations!

Please let know in the comment box below your thoughts, questions?

is this information valuable to you?

Thank you in advance for sharing your thoughts.
Your biggest fan,

Jeroen van der Heide Co-founder & Ecopreneur

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