We live in an age where conventions are being disrupted more frequently than ever, and it is no news how the rise of alternative finance and specifically how equity crowdfunding has challenged the investment landscape.
From an investor's perspective, ‘everyday investors’ now have access to an asset class traditionally reserved for private institutions, and can benefit from managing their own portfolio with no investment management or carry fees. Meanwhile, from an entrepreneur's perspective, whilst not all information is entirely public, the validation of a company’s valuation is shifting from being a private process, to being a very public one.
Initial backing or even social capital from a company’s own loyal network of stakeholders may help its equity crowdfunding round get off the ground but may not be enough to attract the substantial investment it needs to close a round, and therefore access the growth capital it needs. The challenge a company faces, then, is to present a viable investment opportunity at a fair valuation to corral a multitude of investors on the same terms. Although Crowdcube do not advise or approve valuations for businesses that list, we do see hundreds of listings every year, so here are two crucial points that all companies should consider in calculating a valuation.
1. Draw reasonable comparisons
There are many valuations guides available online, but each company is different, so each company has its own set of rules. A basic starting-point is to draw reasonable comparisons with similar companies, and apply objectivity in the process. To determine what constitutes a similar company, simple attributes to consider are the company stage; size; sector; geography; growth rate; funding route; and strategy to deploy the growth capital.
An important comparison to make is the funding lifecycle stage of a company. This will not only help to inform on the amount of equity have available, but also to set a valuation that accommodates for future investment rounds. Even if a reasonably comparative company had an aggressive valuation, setting a relatively lower valuation could generate greater interest in the pitch, provide scope for follow-on rounds, and aim to avoid potential damage through future dilutions. An example of a company who did this well was BeerBods; who raised £155k in 36 hours on Crowdcube in Feb ‘14 with a pre-money valuation of £440k, and did a follow-on round in Aug ‘17 after increasing its revenue fivefold, at a pre-money valuation of £2.25m, all considering competitors HonestBrew and Beer52 completed crowdfunding rounds in between BeerBods’ own two rounds.
2. Act on continuous feedback
The age-old Venture Capital methodology engineers a valuation based on a future trade sale, and backtracks based on a compound discount factor that accounts for the risk and time horizon. This is a very exit-centric method of calculating a business’ valuation but is worth considering given the expectation of investors, generally speaking, is to make a return on investment. Therefore, listening to investors’ opinions both before and during the round is crucial.
Most equity crowdfunding rounds are private until they reach a certain percentage of the round before going public, to strategically gain momentum prior to asking the wider community to come on board. This provides a closed-loop environment for companies to test set valuations before launching a full-circle public marketing campaign. That being said, companies still have the flexibility of being able to change the valuation based on the traction of the campaign, while it is live; so are not completely constrained to the valuation launched at.
In the recent case of field&flower, the company acted on feedback from potential investors via the live forums to have a valuation more inline with competitors Mindful Chef, which successfully funded on Crowdcube at a similar time. In response, field&flower lowered the valuation whilst its pitch was live and at 62% funded, from £12m to £9.5m. Within three days of doing this, the company achieved its fundraising target of £750k.
Given Crowdcube’s 59% pitch success rate so far in 2017, company valuation is one of the many factors that leads to funding success or failure, and one that needs to be carefully considered. Drawing reasonable comparisons and acting on continuous feedback are two critical (but often neglected) tools that can help companies secure funding now, and help them grow in the future.