Tuesday, October 2, 2012

How to value your startup

"What is the appropriate valuation of my business?" It's one of the questions I get the most often from aspiring entrepreneurs. And what usually sparks it is an upcoming financing or pending takeover offer.
The answer is quite simple: Just as with anything, your business is worth what somebody is willing to pay for it. And the methodologies applied by one buyer in one industry may be different from the methodologies applied by another buyer in another industry. 

Here are some ways to value your business in a way that will make sense to you and line up with investor expectations.

To start, let's not forget about the obvious: The natural economic principles of supply and demand apply to valuing your business as well. The more scarce a supply (e.g., your equity in a hot new patented technology business), the higher the demand (e.g., multiple interested investors competing for the deal, and taking up valuation in the process). And, if you cannot create "real demand" from multiple investors, "perceived demand" can often work the same when dealing with one investor.

So, never have an investor think they are the only investor pursuing your business. That will hurt your valuation. And, before you start soliciting investment, make sure your business will be perceived as new and unique to maximize your valuation. A competitive commodity business or "me too" story, will be less demanded, and hence require a lower valuation to close your financing.

Another important factor: the industry in which you operate. Each industry typically has its unique valuation methodologies. A next-generation biotech or clean energy business would get priced at a higher valuation than yet another family diner or widget manufacturer. As an example, a new restaurant may get valued at three to four times earnings before interest, taxes and other items, and a hot dot-com business with meteoric traffic growth could get valued at five to ten times revenues. So, before you approach investors with valuation expectations, make sure.......