What's My Company Worth?
Ask Sherman
December 2009 / January 2010
Volume 7 Number 6
If you're a prospective or actual technology entrepreneur, you may have a question about what to do--and what not to do. Sherman McCorkle is president and CEO of Technology Ventures Corporation, which has been helping entrepreneurs for more than 15 years. He'll answer your questions in this space.
How do I determine the value of my pre-revenue company?
The short answer is that something, even a business, is worth what someone else is willing to pay for it. The longer answer is, "It depends." It depends on why you are asking the question.
Three scenarios come to mind. First, someone has approached you and is interested in acquiring your growing company. Congratulations! A willing customer is the best validation that your idea has merit. The second is that you have begun negotiations with an equity investor and are trying to determine a value for your company so that you can determine how much of your company the investor will own in exchange for his investment. The last scenario is that your spouse has begun questioning whether or not your long hours have been worth it because you are still not bringing home a regular paycheck. While I cannot help you with the last scenario within the scope of this column, the answer to the other two scenarios are a bit more straightforward.
There are several methods of valuation that are taught in business school. The Discounted Cash Flow, Market Comparables, Asset-Based Valuation and the Free Cash Flow Method are all traditional ways of calculating the value or potential selling price of a company with assets and/ or sales. But you are a pre-revenue endeavor and likely have no assets and only a dream about revenues. Therefore the most common method used by investors and buyers is something that I call the Educated Guess Method (EGM).
Under the EGM the value of your business is based on its potential to create revenue minus the risks associated with getting your company to the point where it will create this revenue. The risks and the potential are assessed by the educated people with the money. Both purchasers and equity investors are likely to have their own viewpoints and risk assessment tools that may be based on some of the above mentioned business school valuation methods but at the end of the day valuation of a pre-revenue company is more art than science.
What is the value of the countless personal hours that I have put into my business?
The sad truth is that the value of your company is not based on how many hours or how much money you spent to reach a business milestone, it is based on what someone else thinks achieving that milestone is worth. This may seem an arbitrary estimation, but the closer you are to reaching the revenue generation milestone the more your company may be worth.
Sales are the market validation of the worth of your idea and your company. However, pre-revenue valuations are based largely on how well a company mitigates the risks that would keep them from making sales. Oftentimes the reductions of these risks are conveyed through the use of milestones.
For instance one risk associated with a new technical product may be the market risk associated with intellectual property protection. A significant business milestone may be the issuance of a patent. Other milestones might include the release of the production prototype, a contract with your first distributor, or the most important milestone of all, profitability.
Your business plan should be laid out in a series of achievable, tangible milestones so that you and your investors can track the progress of your company. When you start out your plan is largely ethereal but as you pass your milestones you build trust in your ability to execute your plan and lower the risks associated with bringing your product or service to market.
So think about your progress in terms of milestones, not hours spent and always be working toward that ultimate justification of your hard work, revenues, because that is where the real value resides.
How much of my company will I give up to an equity investor?
You do not "give up" anything; rather someone is investing in what you are doing. The percentage of stock ownership that an equity investor receives in your company is based on the valuation of your company at the time of their investment. Valuation is a negotiated number that is the product of a number of factors including revenues, assets and market comparables.
For instance, if the agreed valuation is $1 million and you are seeking $250,000, one-fourth of the value of your company, to expand your operations, the investor would likely ask for 25 percent of your stock, in exchange for their investment.
Ownership of stock does not necessarily translate into control of the company. The person who can best execute the business plan is the person who will run the company. Most investors are not in the business of running companies. They are in the business of investing capital into companies where it will have the greatest chance of providing a return. Taking over operational control of a company is usually a strategy of last resort for most investors.
Each round of funding that you receive from an investor should be used to help your company grow in value. The more the company is worth, the less stock you will have to provide to an investor in exchange for a given amount of money and the more valuable your stock will become. So don't get caught up in how much you have to give up. Focus on how much you will be able to make your stock grow in value with each investment.
Send your questions to Sherman McCorkle through our contact page.
More
Copyright © 2012 | Innovation America