With several poster-boy startups in India raising massive funds from various investors, the term ‘valuation’ is seen thrown around quite often. It also seems to become what defines a startup: How much is your business and why?
As a result, every startup founder is often concerned about getting the right valuation for his or her company.
While addressing entrepreneurs at T-Hub, Vishnu Giri, partner at PWC India says that valuations of early stage startups are at most times incorrect, but those valuations do come handy in investment deal flows.
The concept of value largely falls under market value and intrinsic value. Market value is the value that a knowledgeable, willing, unpressured buyer would pay to a knowledgeable, willing, unpressured seller in the market. While intrinsic value is value based on an underlying perception of true value including all aspects of the business in terms of both tangible and intangible factors.
However, Vishnu says that valuation is highly subjective and most often depends on what the investor perceives. This is usually because it is difficult to valuate a startup in its early stage because there isnt much historic trends to compare it with.
“The earlier the stage of the startup, the more difficult it is to valuate. That is where subjectivity creeps in. If the company has lot of history, valuation gets easier. For example, Uber shifted on valuation from 25x to 8x in just five months. If we need to valuate Uber’s competitor Lyft, is there a sanctity in Valuing it based on Uber?” Vishnu says.
As a result, in seed funding, investor sentiment is the highest and the money invested is largely based on faith and belief in the founder and the idea.
However, when investing into a startup, investors largely look at their own gains, which is what most founders fear as well. Here are a few Dos and Don’ts lined out by Vishnu for founders to keep in mind while raising funds:
Don’t go to raise funds if you are not ready. Know how to run your operations and build a detailed operational plan. This helps you have a solid idea of the market share you are targeting, the pricing of your service/product and who your target audience will be. Run a detailed market analysis and know which players you are stronger than and who’s stronger than you. Approaching an investor with a strong plan helps instil more confidence.
Don’t raising more funds that required at any point in time. Every time you raise funds, you dilute some stake. As a result, raising more funds than required could result in you eventually losing control of the company. Vishnu says that you should resist investors that come with a minimum ticket size.
“I have seen cases where some are so desperate to raise funds they end up giving majority stake. As a result, the investors control the board - they’ll steer your company. So only raise to extent required. You don’t need the extra money, so why give the extra stake,” Vishnu says.
Be careful of the rights you give up through the investment contracts. Be wary of terms and conditions such as ‘drag along’, ‘tag along’ and ‘liquidation preferences’.
“If your company is valued at say 5 million and he invested say 2 million with a 40% stake with a 3x liquidation preference. Then if you sell your company at a valuation of 6 million, he gets it all and you get nothing. So be careful of these kind of processes,” Vishnu adds.