Equity · Equity distribution

What is the most basic definition of valuation? Basic structure/rules of valuation? How to valuate a startup?

Hammad Khan Supply Chain, procurement & logistics enthusiast, entrepreneur in the making, an idea powerhouse.

Last updated on August 4th, 2017

Basically I am a commerce graduate and have been studying on the internet about entrepreneurship, startups, funding and running a business in the sense of today's venture world. Most of the information I have gathered is through articles and since I have learned almost about everything, I have found myself too hard to wrap my head around this "valuation" thing.

First off, about my idea:

It is an online database and we collect information from public of various sorts, build database and provide analytics to businesses based on that information.

So what can be the most basic definition of Valuation? What is the basic structure of valuating and what are the factors to consider? How to can I valuate my startup which is at very initial stage right now (prototyping)?

Additional information: Please let me know what will my valuation be when I'm raising $200K in the seed? What percentage of equity should I offer or negotiate for from Angel Investors?

Alejandro Cremades Author of The Art of Startup Fundraising & Serial Entrepreneur

Last updated on August 4th, 2017

The basic valuation methods, depending on the stage of the business, are the following:

  • The DCF (Discounted Cash Flow)
  • The First Chicago method
  • Market & Transaction Comparables
  • Asset-Based Valuations such as the Book Value or the Liquidation value
  • Venture Capital Method calculates valuation based on expected rates of return at exit.
  • Berkus Method attributes a range of dollar values to the progress startup entrepreneurs have made in their commercialization activities.
  • Scorecard Valuation Method adjusts the median pre-money valuation for seed/startup deals in a particular region and in the business vertical of the target based on seven characteristics of the company.
  • Risk Factor Summation Method compares 12 characteristics of the target company to what might be expected in a fundable seed/startup company.

Paul Garcia marketing exec & business advisor

August 6th, 2017

Aside from the detailed scenarios Alejandro described for methods of valuing a company, there's a more fundamental factor. Will your service make money and how do you know this?

Ideas a cheap. I have a guy I can pay $10 an idea almost endlessly. That's because ideas don't get you anywhere, it's execution. I've built a database product similar to the type you've described. It compiles over five hundred sources, deals with bureaucracy, harmonizes the data, and takes more than five million records and turns them into about a hundred fifty thousand "usable" unique entries.

The question is how usable, to whom, and what the difficulty level of getting the same/similar information from another source is. Because if you can get it, someone else can get that data and assemble it to. What your business needs to show as value to the customer is why getting the information from you is a better proposition than getting it themselves. THAT's what shows your product has value. And then you can begin to calculate what you can anticipate as revenue from your unique position.

If your data is only a small step up from a commodity, you have a model for what the commodity is being valued at in the marketplace. If your data is a big step up from the commodity, is exclusive in some way, and provides depth that your customers desire, then you have to prove your potential customers are willing to pay. This forecasting is a different value, but also comes with different risks because today you haven't sold anything, no one has sold the unique thing you are creating. And as it's new to market, the credibility of your forecast is highly questioned, in contrast to entering a copycat situation.

The question isn't what amount of equity to offer potential investors, it's whether your company is something investors want equity in. If you are just another machine into which cash gets pumped and more cash comes out, then equity may not even be important.

Before you consider how to assign value to your company, make a list of your risks. The more risk, the less value your company has. You may end up with zero value after you add up all the risks. But that's okay too. There are investors who are comfortable with bigger risks, depending on the product/service and the potential it has.

With most startups, you should start with the assumption your value is zero. You have no customers, you have no product, just an idea. Until you can prove your ability to complete work, to win customers, retain customers, and grow customers, you have nothing to offer except hopes. If you were making widgets, you'd at least have a little bit of collateral that could be sold off if the idea didn't pan out, but in a service business like databases, you have nothing to sell off if the company fails.

So, while it's good to learn about the different valuation models Alejandro describes, today, and until you have your first sale, your company has a value of zero. Until you create your product (execution), you only have an idea. And as I said, ideas are cheap, pocket change cheap.

This isn't meant to discourage you from raising money. Investors value people and ideas too, just differently than when looking at an existing business that has revenue and history. Any number you assign above zero today is complete speculation. As long as you're aware this is how investors will see your estimate, you won't look foolish. Be prepared to show why investor candidates should believe your forecasts. Use existing businesses as examples. Collect information on how your prospective customers are spending their money today, and how much, and what they complain about that makes your product an improvement they would switch their spending to use.

Wilson Foo 1 Project Per Year.

August 5th, 2017

Alejandro has provided you with specific techniques and calculation methods to back your valuation. What you need next is a Financial Road Map that includes your dilution percentage at each and every different stage of your crowdfunding.

Angel 1 / 200K for 20% dilution / $xxx KPI to match

Angel 2 / 450K for 15% dilution / $xxx KPI to match

Seed A1 / 1M for 15% dilution / $xxx KPI to match

Seed A2 / 2.5M for 15% dilution / $xxx KPI to match

At the end of it all, its just numbers and stats that professional Angel Investors or Seed Fund Houses don't believe in because everyone who comes to us shows us a feasible plan.

Unseen valuation also looks into corporate governance, financial expertise, board members, inclusion of independent directors, scalability that is portable without cross border political factors, structured firewalls etc.

Wilson Foo 1 Project Per Year.

August 4th, 2017

Personal perspective is that most startup valuations are basically numbers that your Angel Investor is willing to be comfortable with. With exceptions being holding a special patent or license to rare product or perhaps even assets that can be liquidated so that you have collaterals to back a failed investment.

My definition as startup in this context means any incorporation of company less than 1.5 years old with minimal or zero traction.