Will Your Foal Turn Out To Be a Prize-Winning Horse?
Mature companies are like mature race horses. It’s fairly easy to place a value on them based on their winnings. But startup companies are more like foals. You can study their bloodlines and their conformation, but placing a value on them is more an art than a science.
The most successful angel investors have mastered this art. They’ve developed an exceptional ability to judge how much a young thoroughbred is really worth. They make good judgments about valuation because they know what to look for.
The previous articles (Challenges #1, #2, #3) in this series focused on screening potential investment candidates, doing due diligence, and basing decisions on facts rather than intuition. This article addresses the next challenge in the investment process: placing a value on startups and negotiating favorable terms and conditions.
There are 3 basic approaches to estimate the value of a startup. The cost approach bases judgments on the value of the company’s current assets. The market approach analyzes the size of the market for the company’s products and estimates market share. The income approach looks at the company’s current income stream and makes predictions about future income. A thorough process of valuation uses all 3 approaches.
Coming up with an accurate valuation for a startup is crucial if you’re investing in equities because it’ll determine how big a share of the company your investment will buy. If your investment is equal to 5% of a company’s current value, then you’re entitled to own a proportional share of the company.
Once a value for the company has been established, the process can move on to negotiating terms and conditions. You need to ask some crucial questions. What special rights do early investors receive? What type of securities will be issued to early investors? What assets will investors be due if the company is sold or liquidated?
Placing a value on a startup and negotiating terms and conditions is a complex process. Fortunately, you’re not on your own. Venture Hype is learning exchange for aspiring and motivated angel investors who are interested in seed and startup ventures. The team at Venture Hype shares a passion for bringing practical information to help investors get started, make informed decision, and invest wisely and profitably.
The next article in this series talks about what happens after the investment and what you can do to help your investments grow.
* For series, references are published in the last installment of the series.
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Venture Hype has an interesting concept and an interesting format. It’s apparently well-read. Always good to be controversial and ask probing questions.
