In the section on Valuing, the authors describe the five different valuation approaches and describe and provide solid examples of twelve different methods used by Angel investors to understand the value of the deal.
Some methods are quick and easy, requiring no more than one-third of a napkin and less than fifteen minutes of your time. Others are more detailed and need substantial amounts of time and hard work to execute correctly.
As I have done in the previous two posts, I will continue to write about my understanding of the subject matter from an entrepreneurial perspective. As entrepreneurs, especially in the early stage of start-up or idea, we may have a biased opinion of the company value. However, when seeking funding for the project, the Angels, Venture Capitalists, or Bankers would employ one or more methods described in this chapter to come up with the future value and ROI before deciding to invest. Unless they are greedy and want to squeeze the life out of the entrepreneurs, the investor(s) would not negotiate extremely hard in the seeding phase. Instead, most of the winning angel investors seek highly motivated entrepreneurs with whom they can build a successful relationship (Amis & Stevenson 2001). They let the entrepreneurs use their creativity to create the product or service, which would generate high returns, creating a win-win situation.
Some of the simplest and quickest methods to implement are “$5m limit”, “Rule of thirds,” and “the $2-$5m angel standard”. In all three methods, the “sweet spot” is around $2.5m (Amis & Stevenson 2001). The winning angels have found that numbers between $2m and $5m are reasonable and acceptable for start-ups that have a fair chance of making it without angels playing a controlling role (Amis & Stevenson 2001). Other methods require a more in-depth analysis of the market, looking at the valuation and revenue of similar businesses, and the market percentage the start-up will absorb. If deemed profitable, the investors would make more substantial investments and participate in additional financing rounds, to minimize the dilution and earn higher returns.
As entrepreneurs, we must develop a solid business plan with a realistic valuation before seeking funding. The more in-depth analysis we perform for ourselves, and the more we understand our position in the market, the better the chances of angels and venture capitalists seeing the value in the organization. One way to develop an insightful business plan and valuation proposal are through the use of a compensated advisor (Amis & Stevenson 2001). Agreeing to mutual terms, either paying them for the time or through a percentage of equity, is encouraged and should highly benefit the entrepreneurs. We all have a sense of greed and feel entitled to higher equity shares and royalties, but at the end of the day, if everyone is happy and feels good about the deal, the chances of succeeding are higher.
Lastly, mutually beneficial terms encourage future networking and business deals, which adds value to all parties.
Amis, David, and Howard H. Stevenson. Winning Angels: the Seven Fundamentals of Early-Stage Investing. Financial Times Prentice Hall, 2001.