Fundamentals of valuation for entrepreneurs – key factor in investments

Last week at IIT Mumbai, I had an interactive session with the incubated companies and budding entrepreneurs. Among the range of questions and issues discussed, startup valuation seemed to be the most important point under consideration. Questions ranged from how angel investors do valuations, how much % to share at what levels and how to attract investments at an early stage. Let me explain the concepts in simple terms.

Valuation is the price at which a company can be sold. For example, if you need investments of 1 Cr and are ready to share 25% of your company, then the company pre-money valuation is 3 cr and post-money valuation is 4 cr. Overall, valuation is a factor of investment received and % equity shared. Investors often fix the amount they can give or the % they want to own, and then work backwards!

What is the first step to determine the valuations?

The first step before approaching any investors is to do internal self-assessment of how much money do I need? I have met numerous entrepreneurs who take almost 30 seconds to answer this question when I first meet them. Money can be used for expanding team, marketing your product or taking new office, but unless you have made a business plan for next 12 months, it becomes very difficult to face angel investors or VCs. Let us say you plan to spend 10 lakhs per month for next 12 months, and your revenues will start coming after that, then your cash requirement should be 1.5 cr (12 months plus contingency of 2-3 months). Once you are sure about how much money you need, you can go to next step.

How much % of equity should I offer?

There are various ways this can be answered. One of them is how much you want to share – it could be majority control (>50%), significant minority (>26%) or strategic minority (10%-25%). The other way could be to determine what would be the cash required in the next few years of the company after current round of funding – and work towards keeping your stake at a level which keeps you motivated. Remember, early stage startups need cash every 12-18 months, and you will get diluted at each cash infusion! Other things you may think are what multiples can I get (2*revenues, 10*profits, 100 Rs per customer, 1 lakh per employee etc.), what are the ways I can monetize the intangible assets – team, brand, IP etc.

My experiences

Keeping in consideration the startup stage, a combination of financial, formula based (discounted cash flow, PE multiples) and intangibles based valuations work. One of the company I met set the benchmark as their previous round valuations (they had an angel already!). Another company started with 25 cr expectation and ended with 5 cr as final valuation (always start high and quickly judge the investors’ expectations). Typical valuations at an angel stage are 5-10 crores, with 10%-30% dilution. Keep in mind not to take too much money and dilute too much, or too less money and risk your mortality!

About Nurture Talent Academy

Nurture Talent Academy (www.nurturetalent.com), India's 1st training institute for entrepreneurs, has done over 20 workshops across 7 cities, attended by 275 startups, with over 90% satisfaction rate. Topics covered include finance, marketing and business plan. Amit Grover, Founder, is an IIT Delhi and IIM Indore alumnus, and is a member of Mumbai Angels, having led over 20 early stage investments over last 3.5 years.

- By Amit Grover, Nurture Talent Academy