Because of there is little to no history of revenues of the early stage company, it is difficult to visualize how much the company worth, if it is invest-able in determining which company to invest in. During the assessment and negotiation round, the entrepreneur wants his/her company’s value to be as high as possible and the angels want a value low enough so that they own a reasonable portion of the company for the amount they invest.
There are many valuation methodologies and approaches, which work for both angels and startups. There are options when applying individually or combine these methods as a tool when you look at an opportunity. There is no right or wrong. Each method has pros and cons regarding the deal and timing. According to the authors Amis, D. and Stevenson, H. Winning Angels: The 7 Fundamentals of Early Stage Investing, there are five major approaches including twelve methods:
- Quick and easy approach:
* $5 limit: expect to earn five times your money in five years. It is the most simple and easy to use.
* Berkus method: attributes a range of dollar values to the progress startup entrepreneurs have made in their commercialization activities. This based on a unique and specific formula for valuing company.
* Rule of thirds: Most angels found this method works with the first-round deals that one third of equity should go to the founder, one third to the angels and one third to the management.
* $2m – $5m angel standard: Consider as “acceptable” numbers when asking or set by entrepreneur. It sounds reasonable price range and at the same time not too risky for both sides.
* $2m – $10m internet standard: high range and tend to be valued after proven business successful in internet time.
- Academic/investment banker approach:
* Multiplier method: sounds like a quickest way to value company, it depends on the nature of the business and the industry in which the business operates. Try to look at equity research reports of comparable companies.
* Discounted cash flow (DCF): is used to determine the present value of the expected returns of a business. It is more relied on mathematics rather than price observation.
- Professional Venture capitalist approach:
* Venture capital method: Calculates valuation based on expected rates of return at exit.
- Compensated advisor approach:
* Virtual CEO method: Angel investors are “almost” a part of the management team by providing support, time, and knowledge in exchange for a percentage of equity of the company.
* Advisor method: It is “value-added” investor in providing support and or to participate in a deal in exchange for some modest equity if the deal comes together.
- Value later approach:
* Pre-VC method: Angels “investing cash into a start-up without any share exchanging hands and with no price set on any future transaction”. The company will have different valuations before and after the investment and the angels expect that the term will be the same as professional VC investors (with a discount and or at a premium price) when it comes to VC round.
* O.H. method: Investor is in control. The entrepreneur team is guaranteed 15% of the company after the final round of capital, which is protected by an anti-dilution clause.
As valuing early stage deals, while angel investors appreciate the enthusiasm with which entrepreneurs promote their business concepts, on future opportunities the investor may consider options on the entrepreneur, the industry, the future financing rounds and on exposure to additional relationships. However, angels invest – primarily – in people, not numbers.
Amis, D. and Stevenson, H. Winning Angels: The 7 Fundamentals of Early Stage Investing. Pearson Education Limited, 2001.