11 Aug The Importance of a Correct Valuation
Have you had to raise money for your startup before?
If you are like 99% of entrepreneurs the answer is ‘Yes’. In order to realize a young entrepreneur’s dream of scaling to profitability, funds are needed ─ luckily there are several sources of capital to help fulfill those funding needs.
Typically, raising money from friends and family is the first step when starting a new business. While they can give you that initial needed boost, it’s more than likely that it will not allow you to see the product to fruition, and then find yourself in the position of raising more funding. Upon reaching this stage, more traditional Angel Investors or Venture Capitalist funding is normally the best option for startups in this position, however, for many the capital is never raised and their dream may stop there.
Five23 started to look at why so many entrepreneurs never receive funding. There are a few reasons emerging as to why this is happening. In some cases, the idea itself could be the reason why the investors don’t see any opportunity for the startup to advance. Another unseen aspect is the human factor. Many investments are made based on the team behind the company and their ability to deliver goals and handle responsibilities. If investors feel the team can not meet those expectations, the investment will not be made. Finally, the most important of all reasons, which is consistently overlooked, is an incorrect valuation. More often than not, the entrepreneurs overvalue their company by at least 50%. This reason alone is why four out of five startups never realize their dreams.
When angel investors and venture capitalist look at a company, the first thing they analyze is how much the company is worth. They do this primarily focusing on how the market is growing, what is the future value of the company, possible mergers and acquisitions, etc. When all of these items are weighed, a value is calculated. If this number is more than 20% different from what the startup says they are worth, the investor closes the door. 20% is too great of a difference to overcome in negotiation, and the due diligence process stops before it even starts.
So how can startups keep the due diligence process moving? The simple answer is by having a correct valuation. If the entrepreneur values their company within a margin of 10% to what the investor thinks the company is worth, they are much more likely to close a deal. 10% in either direction can be justified and agreed to easily. But how can founders do this, how can they standardize their valuation to match that of an investor?
The solution is a third party. By having an unbiased outsider look over your business plan, financials and team, you obtain a very accurate and realistic picture of what the company is worth. Valuing a company in this manner is very similar, if not the same, to what an Angel Investor or Venture Capitalist would do. This allows you to be in that margin of 10%, giving you the opportunity to see your company reach its goals.