Hatty Fawcett, founder of Focused For Business, explores why valuing your startup is more of an art than a science, drawing on the practical experience of two founders from Crowdcube’s Funded Club.
If you buy into the idea that price influences demand then when doing equity crowdfunding you’ll want to think hard about your business valuation as it has the power to attract or deter investors. It can make or break your crowdfunding campaign.
Many established businesses have tried and tested tools for calculating a business valuation – but these rely on stable and predictable revenues. What startup can say with certainty what their revenue will be next month, let alone next year? So how do you value the unpredictable?
To help get to the bottom of this thorny but crucial issue, I asked two founders who have both successfully raised equity investment on Crowdcube and how they had reached a valuation for their businesses. Their different approaches highlight that business valuation is as much an art as it is a science.
George Williams, CEO of SmartPlant raised £275,000 at a pre-money valuation of £3 million in November 2017. SmartPlant is an app that makes plant care easy by helping plant owners identify unknown plants and pests, get monthly care info, and chat with over 100 regional experts. When SmartPlant launched its equity crowdfunding campaign the business was 18 months old, had 160,000 members and over 8,600 in-app payments. Investment was needed to extend marketing, recruit a sales team and develop the technology.
I asked George how he developed SmartPlant’s pre-money valuation:
“We’d raised money before so I wanted to show a sensible increase on our last fundraising round. No one likes a “down-round”. I also did a bench-marking exercise against competitors to identify what other businesses had been valued at - at a similar stage to us, and in terms of the technology they’d built and the product-market fit they’d achieved.”
Peter @MovemUK - I did a bench-marking exercise against competitors to identify what other businesses had been valued at.
Peter Ramsey, Founder and CEO of Movem, also raised investment on Crowdcube in November 2017. He raised £370,000 at a pre-money valuation of £2.4 million. Movem is an online property portal that allows tenants to review their rental experiences, whilst also building their own digital rental profile. Agents and landlords can pay to instantly download a tenant's full reference, making the process of renting cheaper, quicker, and less open to fraud. Peter agrees with George that determining a valuation starts with a benchmarking exercise:
“There is no scientific way to value a pre-revenue company, although the conversation can be steered in the right direction by market size, competition sales, successful exits and a strong financial forecast.”
One of the difficulties of early-stage business valuation is it can be difficult to find enough businesses at a similar stage of development and in the same sector to really determine what is the “right” valuation. Where this is the case, it can be helpful to look for “proof points”. These are facts or impartial evidence that demonstrate demand for your products/services and your ability to monetise that demand. By evidencing what you have achieved to date, they build confidence in your crowdfunding pitch.
George Williams evidenced his valuation with tangible routes to market:
“We had built some solid partnerships with major industry players – and were able to announce new partnerships during our crowdfunding campaign. These provided demonstrable evidence on how we would expand our marketing reach quickly and in a targeted way.
I was also able to show significant numbers of customers using our app and share the value to us (and our partners) of each customer. Such figures are better than talking about the potential market. Investors want to know you can both target customer and make money from them. Such data gives credibility to your business forecast and bolsters your business valuation.”
Peter Ramsey was also used tangible evidence to substantiate his valuation. Movem had originally raised £200,000 on Crowdcube in August 2016 and this latest, second round was launched shortly after the business pivoted and relaunched. They had achieved one thousand monthly reviews, were active in 550 cities and had been shortlist for five business awards – an impressive set of “proof points” which gave their valuation credibility.
You could argue that the only business valuation that is real, is when two people agree to buy and sell – a founder needs to be happy with the level of equity (or shares) they are selling and the investor needs to feel the price they are paying for the shares is right. Based on this argument, business valuation is a negotiation. I asked George if he had asked for feedback on his valuation before he put his equity crowdfunding campaign live:
“I tested my valuation with a few trusted people in my “inner circle” of likely investors. They all said something different! Some people thought it was too high, some too low. There is no clear “right” answer and, whilst it confirmed the valuation range we should be working within, ultimately we had to make a decision on what felt right and what our current investors were happy with.”
George @SmartPlantUSA - I tested my valuation with a few trusted people in my “inner circle” of likely investors. They all said something different! Some people thought it was too high, some too low.
Peter feels differently:
“I disagree that it’s a conversation between two people. The reason why so many companies end up being valued £1 million and not £950,000 is because founders want it to be £1 million. It’s a sticky number – but it’s statistically unlikely that so many companies are worth exactly that much!
For me, the conversation is internal. How much would we be happy selling our precious equity for? Once you’ve settled on something, you go to the market and see if anyone is interested in buying [at that price]. This is why [valuation] is difficult - investors will rarely say “Mmm, your valuation should be higher”. Like any market they’re trying to buy shares as cheap as possible.”
To avoid entering into a negotiation, Peter looked for further evidence that supported the business valuation:
“You need to naturally fight this downward pressure [on valuation] by anchoring your price to something tangible, like a financial forecast. You might find that if you valued your company at £1.5 million nobody would bat an eyelid, but does that mean your valuation is really £1.5 million? No!”
Finally I asked George and Peter what advice they had for founders who are in the process of valuing their businesses:
Peter urged founders not to be greedy and to see business valuation as a journey over time:
“Early valuations can be destructive. If you raise at £1m in round 1, then you have to raise higher in round 2, and round 3, or you send a message to investors that your business is under-performing. If your company is slower to grow than predicted you can literally price yourself out the market.”
George urged founders not to think just about the shares they are selling, but also to see what they are gaining via the investment:
“I say it’s a case of “No pain, no gain”. If you require funds to improve, expand or grow your business then the likelihood is you will need to fundraise. It can be very useful having experienced investors on board to support you. You may feel you are “giving away” precious equity but you could be gaining an experienced individual who will make your business a success.”
So, what is the key to reaching the right business valuation? Perhaps there is no one “right” answer. It’s more a case of doing your research, demonstrating how you have already created value with tangible “proof points” and justifying your valuation with clear growth plans in a financial forecast. Bringing all this together is more of an art than a science!