Venture-A-Question

Entrepreneurship is in the air.

You decided to start your own venture because you have a game-changing idea, a dream to pursue or you just wanted to be your own boss. You now find yourself riddled with questions related to innovation, business, management, growth, funding, leadership and others.

Venture-A-Question is an initiative of the VentureBean Knowledge Hub to answer such questions and more. Your questions will be answered periodically by VentureBean Consultants and our Subject Matter Experts.
Go on, Venture-A-Question.

Sample Questions

  • How can your idea be validated and converted into a business?
  • How should you hire team members?
  • How can you manage without external funding?
  • Would a mentor be useful, relevant?
  • What will make your company interesting to an investor?
  • What could be the valuation of your business?
  • How can you increase your customer base?
  • How do you grow to the next stage?

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On Start-up Valuation – How to calculate the valuation of your start-up? Is there a standardized procedure for the same?

Valuation is based on the financial forecast of a business. One person’s forecast scenario for the start-up may vary from another’s view of the future for the very same start-up. The assumptions Kumar makes may be different from what Sheena may believe in. Hence standardisation is not possible. However, in terms of the process followed, there are a few steps that are standard, such as financial forecasting, valuation calculation based on current market multiples and some standard methods such as discounted cash flow etc. This is followed by negotiation and if all goes well, by deal closure.

As an Entrepreneur:

 FIRST

Set out why you want to value: Is it for one or combination of the following reasons?

  • A potential investor is evaluating your business and you want to decide what percentage of your company may be shared with the investor in lieu of money brought into the business. The investor could be an angel, a venture capitalist or a strategic investor. Each one of these persons could view your business differently.
  • You want to share success with employees and plan to set up ESOP Scheme.
  • You want to invite a mentor on-board and give her some shares in the company.
  • You want to get incubated and have been asked to estimate the value of your start-up.
  • You want to estimate value growth over a period of time, say from today to one year from now; to enable decision. For example, you are not sure whether you should seek investment at the current valuation or whether it would be better to wait as the value could increase.

NEXT

Understand the underlying factors in each of the above, which could impact and/or drive the valuation:

  • If money is brought in as investment, you may weigh the expenses against percentage of the company you may be willing to give up.
  • For ESOP, the consideration will be what an employee can gain from getting an option to acquire shares in the company.
  • For mentor or incubation, you need to understand what is the benefit that you get.
  • For decision making, you may need to estimate the requirement of cash over a period of time and then decide if you are willing to bootstrap without taking money now.

MOST RELEVANT

  • To Value, you need a financial forecast If investors or third parties are looking at this forecast, the assumptions need to stand up to scrutiny and be believable. This will be checked during the time of Due Diligence.
  • You need to negotiate during deals.
    • Take the case of a person going to buy a shirt at a street store in the Indian Local Bazaars which exist in every city and town. If the price is stated to be Rs.1200/- one person may buy the shirt for this amount, another may bargain for Rs.1000/- and one may even get it for Rs.800/-. So what is the price of the shirt?
    • Of course, in this case of a start-up, one is not buying a consumable; one is buying into the future of a business. So part of the negotiation is to sell the idea of the business you visualise and make the other party see this growth potential. You need to communicate a believable future plan.
    • Prepare for negotiation by understanding possible deal issues; deal breaker and deal maker issues.
  • Understand what is happening in the market, i.e. deal multiples and deal parameters (for example revenue multiples, user base multiples, earnings multiples etc.
  • Factor in legal and tax aspects, these can be significant sometimes and need to be understood before proceeding with the valuation and deal.
  • Check out this: The Art and Science of Start-up Valuation for Valuation Methods, Process and examples.
  • Here is a 1 hour session at IIITB Campus: E-Axes: Talk The Science and Art of Start-up Valuation.

CALLING OUT

  • Because of all these factors, valuation for start-ups can be tricky.
  • Of the funded companies, only a few survive and only a small handful can justify the valuation.
  • However from an investor perspective, it is a chance taken that the funded start-up will go on to justify the valuation at which the equity shares were picked up.
  • Sometimes this very complexity can be abused and valuation is then a tool for the unscrupulous to use.
  • So as an entrepreneur who believes in ethical business
    • Tread with care before accepting money from anyone AND
    • Take care to see if the valuation is justifiable when looked at in a holistic manner, over a longer period of time.

This question was sent to us by Lakshmi, Founder, Dekko Digital