“What is your rating?”
As a angel investor, this is one of my first questions when talking to founders about a potential investment. I often hear numbers that are either too low or too high.
For example, a founder who graduated from a high-end business school recently told me that his early-stage fintech company is worth $50 million. The startup had two employees who were in business school full time. There was no IP address, no MVP and the founder only had a general idea of the strategy for entering the market. I ended the meeting shortly thereafter, because the factors they used to come to for evaluation had no basis in reality.
Another CEO I spoke with had a game-changing product, a large total available market (TAM), successful bids, some product sales, an impressive team and a well-thought-out strategy to reach the market. When this founder said the business was worth $500,000, she advised her to reconsider her valuation because it was too low.
Not many investors would give this kind of advice to a founder they just met, but because the startup has potential, it encouraged the founder to redo her homework.
What is “evaluation”?
The valuation of a startup company indicates its value at a particular time. The factors that make up the evaluation include the stage of product or service development; proof of concept in the market; CEO and their team; Peer reviews or similar startups; existing strategic relationships and clients; and sales.
Although there is no exact science of how much money you will need in the future, some sectors and industries have patterns that you can look out for.
Entrepreneurs typically value their startup when raising capital, or while awarding stock to their team, board members, and advisors. Getting an accurate appraisal of your startup is crucial, because if you overestimate it, investors will likely not give you any money.
On the other hand, undervaluing your startup means that you give away a lot of stock for less money, or that you undervalue what you’ve built so far.
It is more art than science
There is no straightforward formula to follow when evaluating your startup. Since most startups can’t really demonstrate commercial success at scale, evaluations take into account the nature of the product or service, expectations for the business, and TAM.
You’ve probably heard that valuation is more an art than a science, and that’s often true – startups often don’t have enough concrete data at the early stage and face a host of risk factors that can alter the course of business. Many traditional valuation methods, such as discounted cash flow, are not helpful in valuing early-stage startups. This means that investors have to measure other factors that are not easily quantifiable.
As a founder, your job is to display: