What is it?
Valuation of a company is the process investors and venture capital firms use to determine if they would like to invest in a business, and if so the amount of funds they are willing to invest. The earlier in the economic progression (or stage) of the venture, the less funds they typically receive. Marrian Hudson, contributor for Forbes, describes the process as, “Valuation of a pre-revenue company is often one of the first points of contention that must be negotiated between angels and entrepreneurs. Entrepreneurs want the value to be as high as possible and angels want a value low enough so that they own a reasonable portion of the company for the amount they invest.”
How Does It Work?
There are multiple approaches to evaluating a business, but one that is commonly used amongst entrepreneurial ventures is the development stage, or valuation by stage approach. This approach is often used by angel investors and venture capital firms to create a rough estimate of a company’s value. A guide is generally used to estimate a company value and is dependent upon the venture’s stage in development. Value ranges will vary, depending on investor/firm, but ventures with nothing more than a business plan will typically receive lower valuations, higher valuations coming with progression and development. Some private equity firms provide additional funds as ventures reach certain developmental milestones along their economic progression (Investopedia). The general rule of thumb is the lower a company’s risk, the higher their value will be. An example of a valuation -by-stage model can be found on Investopedia.
It is always difficult to accurately valuate a company’s worth in the early stages, but if able to understand the process and key milestones investor’s look for, not only will IT strengthen your chances at receiving more funding, but will increase your businesses validity and success down the road.
For more information on startup valuation, head to Funders and Founders