ENT 640: Winning Angels: The 7 Fundamentals of Early-Stage Investing

ENT 640 week 4: Valuing

“Valuation is what you are willing to exchange for something else that you want.”

The five approaches to valuation with 12 methods:

  1. Quick and easy
    • $5m limit – never invest in a startup that is valued over $5 million
    • Berkus method – estimate the value of the company based on a simple formula.
      • Sound idea = $1 million
      • Prototype = +$1 million
      • Quality management team = +$1-2 million
      • Quality Board = +$1 million
      • Rollout/sales = +$1 million
      • Total = $1-6 million, reasonable start-up valuation
  • Rule of thirds
    • 1/3 = founders
    • 1/3 = capital providers
    • 1/3 = management
  • $2m-$5m angel standard – most traditional and reasonable chance to succeed value between $2-5million
  • $2m-$10m internet standard – internet investments should not be any more than $10 million
  1. Academic/investment banker
    • Multiplier method – finding the right numbers to use to find the value, a key number in the business plan times an industry standard
      • Example = # of products x amount of product
    • Discounted cash flow – financial calculation = potential future value of company – % of each year reduction between now and then
  2. Professional venture capitalist
    • Venture capital method – how much of a company you need to own to gain return
  3. Compensated advisor
    • Virtual CEO method – provide support to entrepreneur in exchange for equity percentage 1-5% or they may charge $2000-$5000 per month for their services.
    • Advisor method – similar to virtual CEO with less expectations and requires only .25-2% equity in exchange.
  4. Value later
    • Pre-VC method – investing cash without any shares or price 10-50% discount on a VC round, in the form of a loan note
    • O.H. method – entrepreneurial team is guaranteed 15% of the company with angels primarily in control

It’s good to pick two or three methods to use for valuation of a possible opportunity. The book Winning Angels: the 7 fundamentals of early stage investing suggest that the angel standard $2m-$5m is the best valuation method approach. “Anything beyond $5m limits your upside and may not make sense from a valuation standpoint.”

In order to get a win there are four levers of financial return that need to line up, these include:

  1. Whether you choose winners
  2. How the deal is structured
  3. The price you pay
  4. How much dilution occurs

All of these must be acceptable in order to achieve a winning investment. What do investors and winners do to succeed and what tools and tactics do they use?

Investors:

  1. Calculate a lot of numbers
  2. Focus on the plan or the market
  3. Follow other investors
  4. Use a combination of methods

Winners:

  1. Use numbers to discount or kill
  2. Go to Harvard
  3. Look for low-capital, large market opportunities
  4. Pass by it quickly
  5. Leave it to the lead

Tools and Tactics:

  1. $5 million limit
  2. Berkus method

As you can see the investors and the winners strategies are very similar, while the tools and tactics help them determine if the risk is worth the possible gain.

References:

Amis, David, and Howard H. Stevenson. “Valuing.” Winning Angels: The Seven Fundamentals of Early-stage Investing. London: Financial Times Prentice Hall, 2001. N. pag. Print.

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