The valuation equation that equals an attractive investment opportunity
With investment expected to shift towards later-stage rounds, start-up valuations need evidence, momentum and potential to appeal to investors
Figures from the US this month show a cooling off in investor appetite for early stage start-ups. Investment is shifting towards larger funding of the most valuable growth businesses.
It is something that we can expect to happen in the UK as we seem to be have too many frothy early stage valuations and investors are waking up to what value really looks like.
Crowdfunding in particular, seems to have lost track of investment fundamentals and we expect a correction to be imminent. We can predict that it may well prove harder to raise over the next couple of years. So, more than ever, it’s useful to keep in mind what investors are looking for and how they will weigh up your investment offer and valuation against others.
Whilst I’ve written about valuations before this time I will keep it even more simple. The relative attractiveness of a valuation is based on the simple equation below:
The first thing to note is that it has multiplication signs, not plus signs. If any of these elements are missing the result should be zero. Even if one element is fantastically positive a seasoned investor will be hugely wary.
So, to each of the elements in the equation:
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Evidence – does your business have market value?
Evidence is the proof points you have that your proposition is going to be interesting and valuable to your target market.
Ideally there will be some actual customers and revenue. But even at an earlier stage than that, any idea should have some kind of insight and research to back it up.
There are lots of cheap ways to gather feedback – both qualitative and quantitative from potential customers.
My favourite example is from James Averdieck when he launched Gü – the desserts brand. He mocked up his packaging, filled the boxes with sand and snuck into Waitrose and put them in a fridge display.
He also had the foresight to print off a ‘shelf edge’ label. He stood back for a minute until a customer picked up the ‘product’, and then a really tense 30 seconds until she popped it into her basket. (He ran after her and whipped it out before she got to the checkout).
A few experiments like that gave him confidence to give up his day job, take investment and launch the brand. In today’s digital age it is even easier. There are loads of digital tools that put products in front of customers for feedback, or you can start your own conversation on social media.
Momentum – does your business have steam?
Building a business is about getting things done, and investors like to see that an entrepreneur has built up a head of steam, has a clear plan for the next steps and has previously delivered on promises.
A business that has been around for a while – even if there are good reasons, such as the founder still being in full time work – will smell a little stale. Worse still is a business that has been trying to raise investment for a few months.
Potential – will your business grow?
Of course, early stage businesses are all about potential. Making this as real as possible helps to increase the value.
For example: mock-ups of a product or customer experience, visuals of a pipeline of future products, research into the growth of a market or the holy grail of letters of intent or contracts from future customers.
Too many valuations currently are over-weighting the value of potential, based purely on a great idea with very little in the way of evidence or momentum. As an entrepreneur you might say “great, bring it on, the higher the valuation the better”. But you may not be feeling that if subsequently progress proves tough and you have not achieved much prior to having to raise again – you could face not only disgruntled existing investors but also the possibility of a down round.
The three points are valid through funding rounds at different stages of a businesses growth. Whilst a very early stage start-up might be scrabbling about to maximise all three, a growth business might have some more nuanced choices about how they manage the balance across the three dimensions (remembering this is a product not a sum).
For example: it might be more advantageous to develop some new products but be just ready to launch them after a funding round. The funding story could be about evidence the existing products are doing well and evidence that the market will respond positively to the new introductions; momentum is illustrated by the new product development and the potential is bought to life by mock-ups and samples of the new product.
This might be more compelling than launching just before funding and only having early sales evidence which might be low whilst the product embeds in the market.
Are you seeking investment? Startups.co.uk, with Worth Capital, has the Start-Up Series, monthly competitions giving two companies every month the chance to win equity investment of £150,000 each. To find out more visit: www.startups.co.uk/thestartupseries