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Reader Mail - Pre-revenue Company Valuation

By February 14, 2008

One of my readers wrote in with a common question from early-stage entrepreneurs:

I was wondering if you could give me some advice I've been having a hard time finding online. I'm starting an online business - I'm in the midst of creating the content and about to start website development with a firm. My question is the following - while I've purchased around several thousand dollars of equipment on my own, the website costs and other expenses will need to be covered by informal investors, and I'm having a difficult time figuring out what is a fair deal to present to these people (friends and family). Do you have any recommendations how to to value a company that hasn't actually made any money yet? In other words, if someone gives me X dollars, how can I figure out how many units/ percentages in my LLC that should be worth?

Thanks so much for your time

Regards,

BK

It would be great if there were just a simple formula -- established companies can often arrive at a pretty good estimate with a multiplier of revenue. But when you don't have a track record to base it on, you have to consider other factors, like:

  • How close to revenue are you? How far along is the development?
  • How compelling is your product? Is it unique? Does it create high value for your customers?
  • How big is your potential market? Is it growing or shrinking?
  • What kind of revenue do current competitors in the space produce?
  • How clearly defined is your business plan, particularly your marketing plan?
  • Do you have any strategic partners or joint venture partners?
  • Do you have any intellectual property?
  • Do you or someone on your team have extensive industry connections, both in your industry and in your target markets?
  • How much cash have you invested yourself? How much time, i.e., "sweat equity"?

Cayenne Consulting has an excellent High Tech Startup Valuation Estimator that will walk you through these and other questions in a simple multiple-choice questionnaire. You can use that as a starting point. You'll also want to check out the Kauffman Foundation's document collection on Valuing Pre-revenue Companies, which will provide you with more detailed information to refine your valuation model.

One thing is absolutely certain -- while friends and family may be willing to put up money for something they believe in, they'll put up more money, at a more favorable valuation to you, if you've really done your homework and can provide a solid business plan and justification of your valuation.

Comments
March 6, 2008 at 1:50 pm
(1) Armand Rousso says:

hello,

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July 14, 2008 at 7:55 pm
(2) VR 101 says:

Scott–awesome post and I totally agree with your assessment. The earlier stage the company is the more the valuation is based on a negotiated agreement that involves debating all of the points that you mention above.

That said, I think that most sophisticated investors project out the revenues and profits of the investment into the future. They then multiple either revenue or profits by some multiplier to get an exit value and then discount it back. I am a bit biased in saying this because I am the founder of a company called Venture Returns (www.venturereturns.com), and we provide users with valuation ratios for over 700 detailed categories including nearly all of the most recent technology categories (which are always changing). We also allow users to create their own highly tailored category to make sure that their valuation ratios are as accurate as can be. If you have any advice or thoughts on the business, I would love to hear them! Thanks, hope these comments were helpful.

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