In Part I of the article I had discussed how valuing a new business does not have a defined framework and there are endless list of factors that might affect a new company valuation. In this part we will see the essential determinants of valuation and furthermore how investors value a company.
What are the key factors that influence valuation?
Early-stage valuation is commonly described as “an art rather than a science,” which is, for the lack of a better word completely useless and a directionless statement. Let’s look in to the mechanics of what factors influence valuation.
Traction – In an ideal world, your business will be generating revenues and the trajectory of your growth will be something reminiscent of a space shuttle on takeoff. Out of all things that you could possibly show an investor, traction is the number one thing that will convince them. The point of a company’s existence is to get users (or consumers), and if the investor sees users – the proof is in the pudding. So, how many users is considered a good number? If all other things are not going in your favor, but you have 100,000 users, you have a good shot at raising $1M (that is assuming you got them within about 6-8 months). The faster you get them, the more you are worth.
Reputation – Entrepreneurs with prior successful exits in general tend to get higher valuations. But some people have received funding without traction and without significant prior success. One example that comes to mind is that of Kevin Systrom, founder of Instagram, who raised his first $500,000 in a seed round based on a prototype, at the time called Brnb. Kevin worked at Google for two years, but other than that he had no major entrepreneurial success. His VCs said they followed his intuition. As ambiguous a methodology as it may sound, my advice would be that if you can learn how to project the image of the person who gets things done, lack of traction and reputation will not prevent you from raising money at a high valuation.
Markets & Comparables – With nothing to go on but an idea, a team and possibly a product, the value of a business is based largely on what the market says its worth. If you are operating in a hot sector which is experiencing unparalleled growth and has seen numerous sizeable exits, that puts you at an advantage (as long as the market isn’t saturated) yet while an idea that could potentially change the world in a sector that has never been touched before can put you at disadvantage. Investors need something to base their potential return on so if you’re delving into segments of an industry that haven’t been explored then you need more firepower to convince the investor community.
One of the most popular methods to determine an entry and exit value for startups with limited financial history is the market and transaction comparable method. Comparables’ tell an investor how other companies in the market are being valued on some basis which in turn can be applied to your company as a proxy for your value today.