Getting an accurate business valuation is vital for when you are trying to negotiate terms with investors. It is therefore worthwhile paying a lot of attention to the valuation process itself, and making sure you do the research that is needed to effectively prepare yourself, and your business.
It is much easier to enter into negotiations with potential investors when you have an idea about what your business is worth. However, when you are a startup, this is a lot harder to gauge especially since a lot of what you deem to be assets might just be ideas in your head!
Startups are unlikely to have significant revenue streams, or indeed cash flow; all of which makes it harder to assign a value to the business. You will also have invested a lot of time and effort into your startup – but this is even harder to assign a value to!
You should take comfort in the fact that performing such a calculation is truly an art form! It is difficult and, to be absolutely honest, there is no easy or definitive way to actually get to the correct valuation. However, there are a few formulas out there which will help you come up with an estimate, taking into account a range of factors, from competitors and your projects to the amount of effort you’ve applied.
– Follow a method
There are a lot of calculation methods that you can apply to help you, for instance one of the below might help:
1. Cost to re-create method
This method takes into account how much it cost you to start up your business against how much it would cost another party to duplicate what you’ve done, i.e. including the marketing aspects, as well as recruitment, office rental costs and any equipment and materials.
2. Market multiple method
This method takes into account all the other transactions that have taken place within your market (or sector). For instance, if a company operating in a similar field to yours was recently sold for £1.5 million but was twice the size of yours, then your company’s valuation could be estimated using this information.
3. Discounted cash flow method
This method involves forecasting your company’s revenue stream, factoring in any expenses, to calculate the value of your company’s cash flow in the future. For instance, if your company is doing £200,000 in revenue and earning £20,000 in cash flow and you expect to double your revenue to £400,000 the following year, then you can proportionally expect your cash flow to double to £40,000.
– Ignore your personal expenses
For brokers and investors to gain a true picture of how much value is in a business, it is crucial to analyse the financial statement of a company.
The majority of small businesses will always try to minimise their taxes however they can, and often this comes in the form of expensing personal charge to the business account.
However, only by removing these small amounts, i.e. the ‘owner’s discretionary cash flow’ can you get an accurate view of the tax return and really see what the net profit or net loss of your company truly is. This is the picture that will actually affect the valuation.
– Don’t forget about non-financials
There are many factors that can affect the valuation of your startup, not just the financial ones. For instance anything from the owner of the company and the experience of the team to the niche area in which you operate, can be taken into account.
Research shows that often higher valuations will occur with businesses that have been founded by second-time founders. This is because these second-time founders have more experience, no matter if they have failed before or been successful. You need to keep such additional factors in mind when trying to get an accurate valuation.
– Factor in who you are presenting your valuation to
When you are trying to get an accurate valuation, keep in mind that different investment firms will differ in the valuation they assign. For instance, the more successful the investor is, the more likely it is that the valuation will be on the lower side.
Don’t let this put you off. Keep in mind that the better the investors are at the beginning, the greater the chance of achieving a higher valuation. This is because you will have benefitted from the superior advice given by the more successful investors, as well as gaining access to a more influential business network.
It’s also important to consider your audience when stating how you want to receive the money, i.e. if you are asking for £300,000 in cash then you may well only be offered £250,000. If you, on the other hand ask for £150,000 in cash and the rest via finance deal, then you may be more likely to receive the full amount you’re after.
– Don’t be too proud about accepting help
You should always be accepting of impartial advice, since it will be given without emotion. Be conscious of the fact that it is much more difficult to make decisions, or accept decisions when emotion is involved. You will be emotionally invested in your business; therefore it is a good idea to seek external help.
Be sure to look around when choosing a firm to undertake your business valuation. The valuation you are given by such a company (broker) won’t be set in stone but it will help you gain a more accurate idea of what the going rate might be for your business.