Thinking of raising funds for your start-up or generally, want to know how much your start-up is worth? Here are 20 (twenty) key points to note about start-up valuation;
- There are divergent approaches to the valuation of start-ups depending on the maturity, the industry, and the progression of the start-ups.
- For start-ups at the revenue stage, valuation adopts a more traditional quantitative approach and the focus is usually on scaling their operations.
- For start-ups at pre-revenue (essentially developmental) stages, valuation as an art,[1] evaluates the market, the start-up ideas, as well as the people driving it. In other words, it focuses on vital assumptions rather than actuarial ones to gauge the start-up’s potential.
- No single valuation method provides a cure-all solution and more often than not, it may be necessary to combine two or more methods to get a fair valuation.
- Bootstrapping is the self-funding stage where the founders spend their own resources to enhance the value of the start-up. The more enduring and successful the bootstrapping efforts the better the value the founders capture in the form of valuation.
- Pre-money valuation is the value the founders are able to create through their bootstrapping efforts while Post money valuation represents the value of the start-up after receiving funds from investors
- Valuation Cap: This is usually adopted under a safe or note fundraise arrangement. It places a limit on the maximum value a start-up can place on its shares for the purpose of converting the instrument. Founders adopting this approach are encouraged to ensure that this clause does not affect their future fund raise.
- Discount: This is similar to the valuation cap but focuses more on offering the investors a discount as payback for their risks.
- Corporate Governance: The corporate governance position of a start-up is at the forefront of its valuation prospects. Prudent founders will do well to get professional assistance in this respect.
- Tax Implication: The valuation of the start-up could present divergent tax implications for the founders and the start-up alike and it is important for the founders to pay close attention to this.
- Contracts and Agreements: The founders should ensure that they have proper documentation for all key engagements and safeguard their vital differentiators, positional advantages, and proprietary interests.
- Data Privacy and Protection: considering the rising profile of data privacy and protection, it is imperative that founders will pay attention to the startup’s compliance level.
- Regulatory Compliance: start-ups are coming under a barrage of regulatory compliance requirements lately and start-ups that display impressive records of compliance are likely to score higher in the valuation index.
- Due Diligence: Founders will benefit from self-sponsored due diligence from time to time to evaluate the impact of the fast-changing regulatory, governance, market, and other risks on the company and the industry at large.
- Exit strategies: While this may not directly affect the value of the equity in a quantitative manner, an alignment between the investor and the founders on the exit strategies will boost the interest and appetite of the investors.
- Future financing Rounds: Stipulations conferring advantages on the investor’s rights vis a vis the subsequent financiers will go a long way to boost investors’ appetite and by extension boost the attraction to equity in the start-up.
- Intellectual property right: The intellectual property right is the principal component of the start-up valuation and having a proper structure for securing the ownership right and protecting the rights will go a long way to enhance investors’ valuation of the start-up.
- Keyman contracts: the quality and reliability of the team is a key component in the valuation of a start-up. It is therefore helpful to keep a close eye on the company’s contract with the key members of its team.
- Founders Agreement: Specific stipulations on equity rights and obligations contained in the founders’ agreement can bear far-reaching impacts on the valuation of the start-up.
- As founders, you must embrace moderation in valuing your start-up valuation; if you overvalue the start-ups, investors may not be interested, if you undervalue the start-up, you will be giving up a lot of equity for less money or undervaluing what you have built so far.
- Lower valuations mean that you may have to give up more equity to secure an investment while higher valuations mean that you, the founder get to retain more equity in the company.
Conclusion
The above provides a summary of a start-up valuation. For a comprehensive and detailed guide on start-up valuation, kindly consult a professional.
- [1] Notable pre-revenue valuation methods are the venture capital method, Scorecard Valuation Method, The Comparable method, Cost to Duplicate Method, Discounted Cash Flow Method, and Berkus model. Berkus appears the most popular because of its simplicity and knowledge of these models will help founders adequately prepare for healthy runs.
Written by Rodiyyah Bashir for The Trusted Advisors
Email us: info@trustedadvisorslaw.com
Telephone Number: +234 810 159 9159
