Entrepreneurs sometimes feel a little (or very) aggrieved at what they get offered by Business Angels.
Occasionally, the entrepreneurs are justified, but often this disappointment comes from a false expectation.
So, what startup valuation should an entrepreneur expect and how can he or she move the odds in his or her favour?
What to expect
We’ve looked at startup valuations a few times on iBusinessAngel and each time, we come back to the view that pre-revenue businesses are not worth much because they represent the unknown. Now, that may be unfair to many businesses, but experienced business angels have learnt – often the hard way – that a significant majority of pre-revenue businesses never actually generate sales in excess of 10,000 dollars or pounds sterling, let alone become successful businesses.
Therefore, for angel investors, pre-revenue investing is like a punt. Occasionally you win but mostly, you lose. Given these pretty dreadful odds, investors won’t give you a lot of money and want to see a decent chunk of equity for their commitment.
A well know US angel investor – Dave Berkus – reckons that a pre-revenue business with a good pitch and credible argument is worth around $100k – so if they want to raise $50k then that will ‘cost’ 50% of equity.
We have been following developments in the UK equity crowdfunding market and believe that valuations for pre-revenue (sometimes with developed prototypes) are in the region of $300k. Therefore, $50k ‘costs’ 16% of equity.
How entrepreneurs can improve the offer
There are two things to note here. Firstly, a developed proto-type and evidence of real customer demand and a willingness to pay (even if you have not been able to ship the product and take money because it needs to be built) significantly helps to increase the valuation.
Real customers buying a finished product
Secondly, and best of all, if you don’t like the valuation, then build the product anyway and let your customers demonstrate the true value of the business by buying your product.
If you still don’t have enough money to build the product, can you use traditional crowdfunding to raise money – and offer your product or a subscription or similar in return?
Lastly, can you slash your development costs by off-shoring? Probably. And this might make the product development affordable. The downside is that the product development may take longer, but, given the length of time it takes to raise finance (allow six months) you may find that steady and incremental product development increases the speed at which you can get investors on board. This is especially true if you manage to carry a few key customers with you to test and report back on the product.
Lastly, you can increase the value of your business by developing a strong startup team with all the right attributes (ability to work with investors, high self awareness, domain expertise, ability to persuade, influence and lead) with the right skills and experience (an independent non-exec or chairman brings a huge amount of credibility – especially if they are an active investor).
Either way, the right response for entrepreneurs who don’t like the offer, is to improve the proposition. Business Angels, especially, will respect you if you are able to do achieve this and it will help you a great deal in getting to a valuation that you find acceptable.