So often on the popular hit series ABC’s Shark Tank, entrepreneurs and investors have been at odds with regards to what that company is really worth. The business owner will see his or her company worth millions based on sweat equity while the investors looks at tangible factors like earnings, sales, and market share before committing any cash equity.
As a startup, how best can one determine a valuation (what that company is really worth) when pitching to investors? BlackEnterprise.com contacted members of Young Entrepreneur Council (YEC), an invite-only organization comprised of the world’s most promising young entrepreneurs. In partnership with Citi, YEC recently launched StartupCollective, a free virtual mentorship program that helps millions of entrepreneurs start and grow businesses.
Here are 10 tips for best determining your company’s valuation:
1. Look to the Market
As a first time entrepreneur, I was clueless as to valuing my company. Luckily, I had the mentors at gener8tor to help me set an initial valuation ask for the business. After that, the market (investors), will help fine-tune the valuation to what is fair. Keep in mind that where you raise money (midwest, Silicon Valley, west coast, etc.), has an impact on the valuation too.
2. Research Comparables
Early-stage companies, especially those that are pre-revenue, should extensively research comparable firms in the market who have successfully raised funds. Based on the funds raised, you can assume a certain dilution to arrive at a reasonable valuation. When you do this exercise across ten or more companies in your market, you can have more confidence in the valuation you set for your firm.
3. Don’t Fall Into the One Percent Trap
Silicon valley veteran Guy Kawasaki always refers to the key misstep that entrepreneurs make as the one percent trap: taking one percent of really large numbers and then asking, “how hard can one percent be?” Assuming you will have one percent of a market right away might be the biggest contributor to overvaluation. Don’t assume anything without researching feasibility, no matter how easy it may seem.
4. Base It on Profits, Not Revenue
If you had $100,000 in revenue last year, your company is worth 1 to 1.5 times that. This depends on your growth trend and whether your company relies on you. The owner-hit-by-a-bus theory is relevant here. Base your valuation on profits so you look more savvy. The investors will usually only go to about eight times profits.
5. Don’t Let Your Emotions Affect Your Valuation
When we appeared on the first episode of the first season of “Shark Tank,” we definitely overvalued our company, College Hunks Hauling Junk. We had a few hundred thousand in profit at the time, but we asked for a ridiculous valuation. Turns out in hindsight we really weren’t prepared to give up equity because we were emotionally tied to our startup. Startups need to ask themselves what they really want and at what cost. But they must be realistic in their expectations.