Methods investors use to evaluate new start-up companies

29 May Methods investors use to evaluate new start-up companies

• As a Certified Public Accountant located in Weaverville, NC, situated in the greater Asheville, NC market, it is very common for me to interface with start-up companies. Some companies are set up to be one woman or man operation while others are more complex in nature. For example, Asheville is now considered Beer City USA.  This designation is causing a massive growth in local beer manufacturing. We even have a Beer City Festival. Since these businesses are manufacturing oriented they will, by design, require a larger workforce and substantial capital equipment and facility space. And unless the owners are Vanderbilts, it is likely that they will need to find Angel Investors to help them bring their product to market.
  
  One of the key steps in an investors’ assessment of a venture is the valuation of the business. According to “Winning Angels the 7 fundamentals of early stage investing” written by David Amis and Howard Stevenson there are five approaches to valuation.
  
  1. Quick and easy method
  
  2. Academic/investment banker method
  
  3. Professional venture capitalist method
  
  4. Compensated adviser method
  
  5. Value later method
  
  Each of these methods has their pluses and minuses regarding their use and based on your experience and preferences one may be favored over another. During this discussion, I will focus on the quick and easy method as it is a valuation system that works well for early stage investing situations where there is a lack of company history and where there is a high level of unpredictability. That sure sounds like a lot of start-up companies I have seen over the years.
  
  The five quick and easy methods:
  
  1) $5M limit – Howard Stephenson states “Never invest in a start-up deal valued over $5 million. This method is simple, fast and manages the outer limits of what an angel investor is comfortable in risking.
  
  2) Berkus Method– Dave Berkus has created his own investing formula. Typically he spends $200,000 and values the deals based on this formula.
  
  · Sound idea $1M
  
  · Prototype +1 M
  
  · Quality Management team +1-2M
  
  · Quality Board +1M
  
  · Roll-out sales +1M
  
  Thus, the total value will be between $1-6 M
  
  3) The rule of thirds: With early-stage companies Lucius Cary believes that 1/3 should go to the founders, 1/3 to the capital providers and 1/3 to management.
  
  4) $2m-$5M angel standard: Most traditional angel investors invest in companies who have valuations of between $2M-5M as they consider that enough money to give the company a reasonable chance of success
  
  5) $2M-$10M Internet standard: Due to the rapid success of many high-tech startups, there is a willingness to look at companies with a higher valuation point. These types of businesses are usually fast in terms of their development, unfortunately, there is equal potential for the business to be evaluated too high as well.
  
  So, if you are a company that is considering seeking an influx of venture capital from angel investors it is a good idea to evaluate your company and see how you might fall within each of these parameters. You may also benefit from my blog “Keys to attracting angel investors”.

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New Business Start-up Tips from a CPA