When you take advice from your shopping friend, drinking buddy, the person you last met at a startup get-together or the latest mentor thrown at you by an accelerator, you basically get what you pay for. To quote John Huston of Ohio Tech Angels: “You pay peanuts and you get monkeys.”
If this is how you, an entrepreneur and founder, gathers knowledge from mentors and advisors, you are receiving a continuous amount of flawed information. The accumulation of this advice is often referred to as ‘mentor whiplash.’
In my four short years being an advisor to growth stage companies, including startups, one of the subjects that seems to give founders the most stress is the valuation of their company when being evaluated for investment.
To quote Dave McClure of 500 Startups: “If you acquire profitable customers, the valuation and investment will take care of itself.” Â Prior to acquiring those profitable customers and while still in the beta stage of your product development, I would propose completing financings through a convertible debenture structure. This form of financing takes the valuation discussion off of the table. Notwithstanding, if you agree with your investors to issue equity, there are some objective ways to approach the issue without undue stress.
I have had the opportunity to present to various accelerators and angel groups, most recently being Incubes in Toronto, Maple Leaf Angels Entrepreneur Workshop, also in Toronto, and Volta Labs in Halifax. Based on the interest shown in these seminars, this is a topic that creates confusion for entrepreneurs and leaves them with a sense of uncertainty.
Setting the valuation of your company and structuring the investment in your venture are more important to follow on financings than they are to the present investment. A overvalued company or an incorrectly structured investment may orphan your company from future investment rounds. When a previous round of financing has a valuation that was too high or the company did not meet it’s performance metrics then often the case is that future rounds will be down rounds. A situation that is often predatory to the company and investors alike.
When the Chair of the Federal Reserve, Janet Yellen, takes dead aim at social media company valuations, there is general concern of the inflated prices of the stock market and the over-inflated price of early stage companies.
I leave you with some final words on valuation. Don’t become overly concerned with valuation. Seed investors should not want to own more than 30 per cent of the company for their initial stake. The investor has to have a strategic economic benefit in investing in your company and the investor has to leave enough equity for the founders to ensure they are motivated to grow the company.
The only fatal mistake for the founder is to grow into bankruptcy and run out of cash.
I will be following up this article in the coming weeks with an introduction to the Shamrock Valuation Method and several other well known methods for valuing pre-commercialized companies.
