Budding entrepreneurs often wonder where investment comes from.
Whether it’s on Shark Tank or in Bloomberg, we see all the time different companies getting an array of amounts…usually in the millions. Some companies only get $2 million but could completely change the world, while others are ‘unicorn status’, raising $100 million from banks like Goldman Sachs. Regardless of the case, the process of going through an evaluation is still the same, and a core function of how startups are able to raise money.
Evaluations are the process of assessing how much a startup is worth currently, as well as how much they could be worth in the future. In laymen’s terms, it’s slapping a price tag on a company, stating how much it would sell for. From there, investors are able to gauge how much of that total price tag they want to buy and for how much, kickstarting the capital necessary to get many of the startups you’re familiar with off the ground, and into development.
Although considered a pretty powerful tool for entrepreneurs, evaluations aren’t talked about enough. That’s why if you’re considering launching a project soon, we’ve put together a helpful guide on what you need to know, as well as how an accountant can possibly help. Here’s what you need to know:
Understanding Revenue vs. Pre-Revenue
A lot of startups work off the basis of pre-revenue. While gauging the qualifications of a founder is ultimately up to the investor at hand, understanding the finances is something anyone should be able to digest, including those businesses that haven’t made any money yet. However, how exactly can we gauge the success of a company that isn’t developed yet?
The valuation for a company with revenue is relatively simple, where an accountant can look at the books and gauge the profitability over time with accuracy; however, the process for pre-revenue gets a little bit more complicated.
For companies that haven’t made any money yet, there a slew of other factors that are considered when assessing the value of a company. Some of the strongest considerations are what’s proprietary about the company (I.E.: does it contain a trade secret, patent, or piece of software not on the market?), how valuable the team is per their industry, and what will ultimately bring in profit. Finally, pre-revenue is also about understanding and predicting reasonable growth, which starts with knowing your field.
Gauging Similar Companies in Your Field
When looking at your field, the first cursor you should find is who your competitors are and why. Take a stab at trying to see what their estimated revenues might be, as well as what that compares to industry-wide. From there, it’s crucial to understand the importance of market cap, which is the estimated number of consumers for a product. With a better understanding of these numbers off the jump, you can then start to gauge how you’re different, as well as what that will ultimately mean long-term.
Once you’ve established where your evaluation is, an accountant can help quite a bit with putting the numbers on paper.
Knowing What a Reasonable Evaluation Even Looks Like
As we stated above, a big part of evaluations is knowing what your predicted growth will even be. For example, an AI startup with proprietary software that boasts it can accurately predict shopping patterns (but is untested on the market) might receive an evaluation between $2 million to $5 million. Almost every company conducting its first round of investment is in what’s called their ‘Seed’ round, which is a common term for when startups raise from friends, family, and angel investors. Rounds after that include Series A, Series B, and so on and so forth, with each round gauging a new level of evaluation; for example, Series A companies are usually considered to have a product-market fit, so they’re estimated to be worth around $10 million.
The simplest way to think of evaluations is the process of putting a price tag on a company. That is, if you were to buy this company today, what do you think would be a fair price to buy it? This is a big reason why we have these standards like Series A, B, C, etc because it helps investors understand the size and growth of the company, as well as the types of capital firms that have put money in (when you get later in the alphabet, more banks like JP Morgan might have a stake). As for you, however, a reasonable evaluation should boil down to where you fit in a seed round.
Most seed rounds are really just about getting enough capital to create a product-market fit. So, if your startup is a brewery that has a world-renown brewer, the fundraise would most likely cover the cost of labor, equipment, licensing, branding, etc…or, the typical costs of starting a business. Anything too high over that and investors might be spooked by your financial acumen, while aiming too low might put you in a deal that doesn’t deliver enough runway (the amount of time before your cash runs out). Remember, investment isn’t just ‘free money’ but rather someone buying a chunk of your business…something you worked hard to develop; don’t sell that piece for anything less than what you might think it’s worth, because investors are going to practically serve as your boss as well.
Giving an Investor Digestible Numbers
Once you’ve established where your evaluation is, an accountant can help quite a bit with putting the numbers on paper. Even if you’re thinking a bunch of charts and graphs will show off that you really know your stuff, putting your data into easy, digestible terms will exemplify you know how to communicate and articulate your whole plan. Business is a numbers game, and as long as you can speak the language, you’ll find yourself providing a foundation built off an honest value that can be built from the ground up.
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