Lessons from Dragons’ Den, week 4: Wild valuations show us the importance of getting real
Startups offers ways to put a realistic figure on your business
This week, Duncan Bannatyne told applicant Fraser Allen that his product, a safe which can be attached to a sunlounger for the protection of valuables on the beach, was “definitely in the top ten of the worst ideas ever to come into the Den”. Given the show has previously brought us everything from cucumber holders to edible dog greeting cards, the investor's words were damning indeed. Bannatyne's rebuke probably wouldn't have been quite so stinging had Allen provided a more realistic valuation of his company. He was offering the Dragons a 5% stake in his company for £150,000, thereby valuing his business at £3m – a ridiculous figure, given that the product carries no commercial pedigree and has little more than a patent to commend it. Allen's obliteration clearly demonstrated the pitfalls of plucking a valuation out of thin air. But, as a start-up entrepreneur, how do you go about finding a more realistic figure? Well here are five quick and easy tips to help you…
Understand the process
If you want to come up with a rational valuation, you first need to get to grips with the process, which can be fiendishly complicated. Talk to a broker, advisor and accountant, and ask them how your business should be valued. The method of valuation will vary according to your industry; if you're a document storage company, for example, the industry standard for business valuation is typically based on revenues, whereas engineering firms are valued on assets. Potential investors will expect you to value your business according to market convention, so you need to get this right.
Look at the bigger picture
Ultimately, you need to have a clear idea of your market value – so it's crucial that you put your own pride and ambition aside, and evaluate the business clinically and objectively. Look at your market, your competitors, and the precedent for business valuations in your sector, and think about how you differentiate your product or service from its rivals. Howard Weston, managing director of business valuation specialist Lucas & Weston, told us: “The key thing is a business is worth whatever anyone will buy it for. To you it might be worth £1m, but if you can't get someone to pay that it's meaningless.”
Get the figures right
As a start-up trying to secure investment, it's essential that you can demonstrate a knowledge of financials, and the performance of your company. If you get your figure wrong in your pitch, an investor could tear you to shreds. Go back over old receipts and invoices to get a clear idea of how much you've spent in establishing the business, and use orders, written statements of interest and customer feedback to calculate future growth; ideally, you should have three years' financial projections when you come to pitch your business for sale or investment. Finally, and most importantly, you need to ensure the figures in your business plan are spot on. According to Howard Weston, most Dragons' Den entrants fail to think about this from the right perspective: “What most people on Dragons' Den don't do is plan the business from the point of sale backwards. If you want to sell the company for £5m, you need to think about how to get there, and plan logical steps towards the goal. That's your business plan.”
Work out a multiple
If you're going to base your valuation on financial returns, you'll need to come up with a sensible multiple – that is, a factor by which you multiply your existing earnings to deliver an overall final figure. The multiple starts off at nothing, and goes up according to how successful you are; the level of increase usually depends on how long you've been trading, and the amount you are making in profit. Realistically, profits of £250,000 or less should have a multiple no higher than three, unless you have something very unique like a patent, a legally binding service contract, or a geographically significant location.
Get it checked out
Once you've come up with a figure for your business, you'll need to get it checked out and verified. There are loads of people you can contact for advice, including corporate finance advisors, independent financial advisors, business brokers, and even knowledgeable friends. According to Howard Weston, “there is no right or wrong – the only valuation that matters is when money is transferred. But everyone has an opinion, and everyone can offer you tips.”