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Sunday, 19 March 2017

Valuation Game Theory

Q: Ever wonder how founders and angels assess a fair value for early stage businesses?
A: So do they..!


Valuation for early stage businesses and start-ups is a constant subject of discussion, intrigue, occasional scepticism and even downright anger amongst angels. Equally, founders looking to the momentum and waypoints for their business are carefully considering individual valuations and the overall runway, funding and trajectory of their enterprises when launching a round and considering it's positioning in relation to present and future funding needs, let alone what they need to do with the money. Giving away too much too soon can seriously weigh on a business and reduce options for financial manoeuvre in mid-life.


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In truth, valuation can be seen as symptomatic of ambition via a 'high' number whilst, in the alternative, a lower number can have the potential to engage angels more fully by engendering a sense that they are getting a one-off bargain, and therefore involve them in greater numbers (bringing contacts, advice, co-funding and investor-advisors) or it can be almost anything in between. The perception of a relatively modest valuation can entice through a sense of a greater stake in the cap table, or ironically a very high and greatly uplifted number from a relatively recent earlier round can leave investors scrabbling hungrily for even a small part of a rapidly scaling entity with clear intent on a large multiple exit via trade sale or even IPO.

It's all in the execution.. both of the business itself and the funding round/pitch, although post pitch due diligence will in any case tease out crucial supporting detail or find weaknesses in the apparent case.

A high valuation delivered during an exceptional pitch for a business that is clearly growing very quickly is one thing but the same number valuation for a business stretching there with less foundation or any sense of lack of conviction or bluster when delivered, risks being quickly and summarily dismissed. This will happen especially if the business sits in a niche where few of the angels have much previous experience and therefore may lack confidence in the multiples and timeline, or the perception of many competing businesses and little obvious 'moat'/USP or IP protection..The same valuation number, all else being equal, in less confident or credible hands can be the death knell of a round or a relationship with a syndicate, although there is often negotiation, barter and pushback, and a experienced lead investor or investor NED can be a valuable bridge here in finding the best compromise.. it's a sales process when you come down to it..

The attitude of existing investors present when following on has especial sway with other angel investors; they listen to their own!

Angels can be a contrary lot to the extent that such a high valuation in relation to a far lower recent round can actually create demand through scarcity with a high ticket price for this round; alternatively it can absolutely turn people off - it all depends on the trajectory of the business, the credibility, authenticity and overall execution of the founder and their team and of course the attitude of the individual angels and VCs. The silicon valley culture around high valuations, high exit multiple assumptions and consequent risk perceptions isn’t often found outside the US..

The type of business, the possible adjacent nature of a recent exit on a high multiple and any financial statistics that show clear progress are all germane and relevant to this.

As in many other angel and investing areas, there's no 'right' or 'wrong' answers,; if we're honest with ourselves, some of the bigger exits have surprised us from businesses we had qualms about, whilst 'hot properties' can fall by the wayside. However thorough our due diligence, there's always an element of chance around such early stage businesses; markets and customers evolve, as do their competitive landscapes.



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