A reflection on “Winning Angels: The 7 Fundamentals of early stage investing” by: David Amis and Howard Stevenson
If I were to ever decide to be a venture capitalist, I would predict this to be the most difficult part of the process for me. Since investing goes both ways (investor to entrepreneur and entrepreneur to investor), I better figure it out fast!
One of the main reasons I think valuing would be the most difficult part of the investment process for me is that I do not predict numbers based on behavior well. I think I need to tap into other areas of my life and determine how I make those predictions and figure out how to apply it to business valuing.
The reading, valuation section, identifies 12 methods of valuation. These methods are broken down further into sub-methods or approaches.
Quick and Easy
The five (5) methods of Quick and Easy are $5mil limit, Berkus method, Rule of thirds, $2m – $5m angel standard, and $2m – $5m internet standard.
Of the five I would most likely rule out Rule of Thirds first. It is my experience that the works or value added by all parties is not equal. Depending on the investment, one third stake may not be equitable for anyone other than the founders. Between the founders and the Venture Capitalist (VC) they hold the most risk in the business. The only reason I would say that the managers would get one third is if they managers with proven records of moving the needle.
The Berkus method had great measurements for how much to invest. Basically, the better the deal, the more the investment.
Last, I must be unsophisticated or lack the vision for significant progress because my eyes popped out of my head at the thought of asking for less than $2m as a bad thing!
The two (2) methods for academic/investment banker are multiplier and discounted cash flow.
These two methods didn’t seems as different as the examples provided by the different angels, but one seems to require more experience or intuition to calculate.
The multiplier method is similar to how I calculate how long it will take my staff to complete a project OR how many staff members I will need for a project or season. It’s fairly simple math. There are variables that have to be considered based on projects (or industries in the case of investment), but it can be a great way of completing valuation.
Professional Venture Capitalist
There is one (1) method and it made me thing of Shark Tank again. As a VC, there are financial goals that they are setting. Some may set annual goals, goals per investment, goals per industry, etc. To reach their goals, this method is critical! It is an easy way to combine the other method (Multiplier Method) to determine the percentage of the company to ask for.
I would presume needing to be a numbers person to get this method correct consistently.
I stated earlier that I am not really a gambler and I am not a numbers person, but I do work extremely hard. I know how to drive results. I supervisor of mine has attributed me to taking small ideas and producing big results.
The two (2) methods of the Compensated Advisor sound more “safe” to me, but can be unappealing if you are concerned with your time. Instead of trading money (your money) for stake in the business, you are trading time.
To me these two methods sounded like short term contracts that would serves as long-term residual income.
The last two (2) methods are the Pre-VC Method and O.H. Method. These methods are for confident investors that have money, money, money! They are less concerned with the valuation of the company, but that’s because they get more in the end (provided the company is successful).
Elaina, I am with you. I think that the valuation part is really tough. I was good at some types of math, but I’ve never been good at thinking through concepts with numbers. It is difficult for me to conceptualize an idea that is mainly based off of numbers. I also thought that this chapter would be a bit different initially. I thought it would cover how angels should attribute a valuation to a company. Personally that is the most confusing part for me when watching things like Shark Tank. I want to know more about how to create valuations, and how to do it in a way that I can justify to potential investors or bankers. I hope this is something we will have the chance to study more in depth during another class.
I understand the struggle! They did say in the reading that the valuation methods are learned through experience, sometimes trial and error. Shark Tank is always interesting to me because the offers move so fast. You really have to know as an entrepreneur what you are willing to “allow” and also…the valuation of your company! A great way to get more comfortable with something is to soak up all the knowledge that you can, even if it’s uncomfortable. The more you do it the more familiar it becomes.
Your website looks fantastic! I also enjoyed reading your post on valuing. You did a great job and thoroughly explained each approach of investing. I agree that having knowledge of the various valuation methods is beneficial to entrepreneurs, and of course, investors. In addition to investing, I have discovered that there are many others reasons why entrepreneurs may need to seek out business valuations, such as estate planning.
Thanks so much, Elizabeth! This book is written for those interested in early investment, but it is also very helpful for an entrepreneur that is interested in acquiring investors. It is packed full of helpful tools and insight to what investors will be looking for and how your should position and present your self.
Great review of the valuing section. I think valuing is a very important part of the process and one thing that can help is a thorough feasibility analysis and chart of accounts. I was in the same boat, not quite getting the concept of valuing the business idea or a product, but the more you understand the ins and outs of it, the value becomes easier to determine.
Valuation is an important part of making your business successful. It is import not to associate value with capitol alone. There is so much more associate with value. Having a product that has validity meeting a current need brings value alone. I enjoyed reading your post, you have some great insight. I look forward to reading future post.
$2 million does seem like a high bar for being the minimum an entrepreneur should ask for. I think the important thing to remember though is that the $2 million figure is the low bar for an angel investor to get in on. Less than that the entrepreneur can probably raise the capital they need through small business loans or family and friends. That small business isn’t really ready to receive the large investment that angel investors usually invest.
I also think I would let another lead investor do the valuation or hire an experienced start up advisor.
2020 Elaina has really big eyes at the sight of $2M, but you’re right it’s not as high as it seems! It’s basically like making a quarter of a million 8x. Piece of cake! No, but really, with the right business plan and structure, several million should be your FIRST goal.