Early stage start-up valuation

Early stage start-up valuation

Apr 25, 2016
Early stage start-up valuation: assumptions and drivers
Luisa Sykes Luisa Sykes
Why is valuation the touchstone for both entrepreneurs and investors? How can we come up with a credible valuation for early stage start-ups? At early stages the start-up value is close to zero but the potential growth will drive the ‘theoretical value’.

Entrepreneurs are motivated to place value on their start-ups to raise money, while investors focus on the value of their investments to generate liquidity. From the point of view of the entrepreneur the most important aspect is the money the company requires to develop its products and services and progress to the next stage and the next round of investment. From the point of view of the investor, future prospects and the return on the investment are the key elements.

The valuation process from the point of view of the entrepreneur encompasses two crucial steps:
  1. Entrepreneur determines how much money is required to accomplish the current stage of business development. 
  2. Entrepreneur decides how much of the company to give away.
If the entrepreneur calculates a sum of £150,000 will be needed and decides to give away 5% to the investor – then the value of the company will be £3 million!

Investors of course need to be convinced the company will fulfil its valuation potential. Early stage valuation is trickier because of high risks and a wide range of unpredictable factors impacting  projects. Investors concentrate on the following factors: probability of success, timeframe to exit and quality of the management team. There are aspects which will swing investors:
  • Traction – number of users/ followers became the number one influential factor and main key driver for most tech star-ups. It gives a strong indication of success potential.
  • Track record – proven business acumen or previous successful start-up experience often persuades investors.
  • Project team – a strong leading team comprising individuals with complementary skills is well regarded by investors.
  • Revenue potential – analysis of potential revenue generation is favoured by VCs. At early stages the analysis focuses not just on revenue generation but how fast the enterprise grows.
  • Distribution channels – clear vision outlining how to reach and grow the number of users/customers will be a great advantage from the point of view of investors.
Investors will be interested in analysing how long it will take for a start-up to be profitable and will always prefer a fast growing start-up with a quick route to profitability as the valuation will be considerably higher than a steady growing business.

To avoid nasty surprises entrepreneurs should define how much equity they want to give away and adopt a clear investment strategy. Fast growth versus steady growth? High valuation connected to high growth is normally an attractive proposition for investors.  For the entrepreneur high valuation with high growth means the start-up will be going to the next round of investment with bargaining power and able to choose favourable investment terms. Starting with a high valuation can also become a risky strategy – it means your next round of investment must be high with a proven track record between the two seed rounds. If not the entrepreneur risks running out of cash or must settle for less favourable investment terms.

  • VIA
  • Luisa Sykes