Articles
8 February 2012

Finding Worth

The Importance of Startup Valuation

by Heather Beers

08 February 2012—

Ready to go after big capital? 

Got a great idea? Check. Thorough business plan? Check. Captivating PowerPoint presentation? Check. Bullet-proof business valuation? Well…

One of the biggest mistakes entrepreneurs make is pricing themselves with too high a valuation, according to Brock Blake, CEO of Funding Universe, a Salt Lake City-based organization that connects qualified entrepreneurs with venture capital firms, angel investors and lending sources. An inaccurate valuation could hurt your chances in the short- and long-term, so it behooves every entrepreneur to heed the experts’ advice when it comes to a proper valuation.

 

What is Valuation?

Blake offers a little Valuation 101, explaining, “Valuation is one of the more difficult things for entrepreneurs to understand. It’s not a science—it’s more of an art. Some people think you can do this fancy formula, that there’s some sort of exact way you can put a number into a spreadsheet and it’ll tell you what your valuation is. That’s not the case. 

“Unfortunately, too often we see business owners who hire an accountant who’s used to taking established companies—they may not be familiar with early stage valuation—and they’ll take [the startup’s] financial projections and do some sort of discounted cash flow valuation. But this is unrealistic and makes entrepreneurs look naïve when they approach investors.”

Blake also explains that valuations are really market-driven. A savvy valuation analyst will see what similar deals are currently being funded, what their valuation is, and what your strengths and weaknesses are by comparison. (Picture the last time you had your home appraised, and you’ll get the idea.)

 

How to Increase Your Value

Since a sound valuation can make or break your chances for funding, Blake urges companies to prepare. “So much of valuation is an indicator of companies’ risk, so the way to increase your valuation is to reduce your risk,” he says. Some of his advice includes: 

• Get traction. Scratch and claw your way through the early stages to prove you can bootstrap. This will go a long way in persuading investors they can trust your company’s ability to perform.

• Place the right kind of people with the right kind of experience on your management team.

• Make sure your technology is completely developed.

• Have partnership or distribution deals already in place.

• If possible, reach the point where you are bringing in revenue.

 

Parnell Black, CEO of the Salt Lake City-based National Association of Certified Valuation Analysts, which represents more than 6,500 members in the U.S. and other countries, also suggests, “One of most important things in building and preserving value in a business is to have systems and processes in place that are almost automatic. And it’s important to have those systems documented.”

When it comes to documentation, Black also advises companies maintain thorough accounting records. “Obviously, to measure the value of the company, you need to analyze the financial information, so make sure you’ve kept good records,” he says. 

Black also gives the age-old “don’t put all your eggs in one basket” advice when he cautions against being overly dependent on any one company leader, client or distributor. He explains that investors need to know your company can survive a change in management or the loss of a client or supplier.

And finally, just say no to company perks. “In a lot of privately owned companies, you’ll find the owners and managers taking out a lot of perks from the company. I advocate against that—the reason is it distorts the real success of the company,” Black says. “A lot of those perks get buried in the company, and they lower the net income. The lower the net income, the lower the value of the company.” 

He suggests that instead of taking perks, management could increase their compensation. “When analysts valuate a company, they don’t look at what the executives are paying themselves, they look at what a comparable manager or CEO in a similar company would be deriving. They’ll go to databases with income averages for different types of positions, and they will adjust that based on what proper compensation should be, rather than what your actual compensation is.”

 

After the Capital

Once you’ve dotted your i’s, crossed your t’s, gotten a solid valuation and even snagged some capital, are you done?

Black recommends getting regular valuations, about every two years. “By talking with a valuator, you can learn a lot about your company. The valuator must analyze all the strengths and weaknesses of your company. You get a thorough analysis, unlike anything else provided by in the consulting industry. What can come out of that process is a better understanding of what you as a business owner can do to improve the value of your company.”

So congratulate yourself on your great idea, your thorough business plan and your captivating presentation. Now that you know what you need for a good valuation, you’ll be ready to land—and grow with—that big money.   


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