Bure Valley Group is an investment brokerage business which links successful investors with exciting, innovative UK startups seeking funding. This content is for information purposes only and should not be taken as financial or investment advice.
One of the most difficult judgments successful investors need to make is how much potential a company in its infancy possesses. Will this startup flop into a total failure or could it grow into the next Apple, Twitter or Craigslist? Which criteria should you use and, crucially, how can you accurately value an early-stage company to negotiate reasonable ownership?
In this short guide, our investment team here at Bure Valley Group offer some thoughts on early-stage company valuation and what options are available to prospective investors. To find out more about our own EIS and other investment opportunities, visit our portfolio page here. To enquire about our latest projects and funding, you can reach us via:
+44 160 334 0827
Why valuation matters
There is no universally-agreed way to value a startup. It is often said that the valuation of infant companies is more of an art than a science. Yet finding legitimate ways to perform valuations is crucial both for the entrepreneur and the investor; after all, it will determine how much the latter can own in the business in exchange for their investment. For example, suppose a business owner seeks a £700,000 investment for where a pre-money valuation stands at £2.8m, which would give the investor a 25% stake in the business. If instead the pre-money valuation is revised to £4m then the stake changes to 17.5%.
Ways to value startups
Here are some of the valid, time-honoured approaches which can be used to value an early-stage company seeking investment:
Cash flow analysis
This is a common way to value publicly listed companies and it’s sometimes called discounted cash flow analysis (DCF). There are different models used in cash flow analysis but they all essentially involve making an estimation of how much money the company is expected to make in the future. The cash flow is often called “discounted” because the worth of the future cash expected to stakeholders is worked out using a discount rate. Of course, working out how much an early-stage company will eventually make is, at best, an educated guess. Typically, business owners are very optimistic and it takes the help of an investment firm (such as ourselves here at Bure Valley Group) to help manage expectations.
Projections of future performance
One of the limitations of early-stage company valuation lies in the lack of historical data. Whilst publicly-traded companies have often operated for many years with a clearly-accessible record of performance data for investors, startups have no such data available. However, it is possible to make future performance projections based on different versions of the “multiples method” (e.g. First Chicago Method). Here, the target startup is compared to a set of similar businesses which are already operating in the sector and at the same stage in the business development cycle. This can give investors a good idea of where the target could end up, although one big drawback is that the approach risks over/under-valuing the sector in question.
The Berkus Method
Devised by the famous angel investor Dave Berkus, this method involves investors taking a look at five aspects of the target company and assigning a value to each one. These aspects are:
- The “soundness” of the idea.
- The quality and viability of the product.
- The quality of the team operating the business.
- The quality of the board.
- The performance of initial sales.
This approach is often attractive to prospective investors as it helps to quantify the risk involved with critical aspects of the business. If three out of the five score poorly, for instance, then the business quickly starts to look like a bad investment. If all look healthy, however, then prospects look much better. Similar methods have been developed to build on this approach such as the Payne Scorecard Method. This method looks at other criteria such as the sales channels available to the target business, the “size of the opportunity” and “stage of the business”.
The weakness of this approach, of course, is that it places a lot of weight upon the instincts, gut feelings and personal judgement of the investor. These might be correct for much of the time, yet it is difficult – if not impossible – to make accurate judgements 100% of the time. Here, it can be helpful to incorporate some of the other aforementioned methods into the valuation process as well. As the company in question develops and more performance data becomes available, it can then be sensible to shift focus towards more quantity-based methods.
Many factors and influences can determine the valuation of an early-stage company. Many of these are helpful and valid, whilst others might be the product of investor bias, inexperience or short-sightedness. Here at Bure Valley Group, our team is here to assist.
If you are a successful investor looking for EIS investment opportunities, or if you are a business owner looking for funding, then we’d love to hear from you.
Get in touch today to start a conversation with our team, and discuss some of the great investment memorandums we have available:
+44 160 334 0827