The early-stage valuation of the investment in a startup (that is, before the business starts generating revenues) is more of an art than science. Nevertheless, the question of the price will sooner or later crop up during meetings with an investor. This is why one needs to price the project somehow. How to do that?
While selling one of my Polish startups, I decided to do some research on Quora about how this looks like in the markets that are more developed than Poland (which should also fit to Nigeria).
First, I decided to ask whether “DCF (discounted cash flow) pricing” — pricing based on forecasting revenues — is used at this stage. As I had expected, the answers were mostly like “not as a primary metric”.
Okay. Then I asked another question – what if we don’t have revenue data?
The answers I received indicates that what is taken into consideration is the market data (from the financial transactions market!). It means the data about:
1. Similar investment transactions
2. Exits in a given sector
It is useful to create a reasonable way of value and sales building in our business, because it enables us to offer to the investor some number that could be negotiated later on. For me, it means I have to create some model in Excel.
This is why I suggest a three-step approach. So I don’t ramble on for too long, I will describe this approach in general and maybe go into detail in further posts. Here is the type of data we need to collect if we want to evaluate, at least generally, the value/price of the investment project that is in its early stage:
A. Assumptions. Market analysis – looking for the market financial benchmarks
Has the company analogous to yours already secured funding? – look for this information in incubators, funds, etc. Try to find out what valuation they got.
Were there any acquisitions of companies like yours? You have to be an expert in this area – get to know about it, do the research.
How big is the market? There will certainly be lots of reports if the market is interesting (e.g. mobile) for your market as well as for the rest of the world.
How the market is developing? It pays to invest your time in the markets that show high dynamics of growth – you will often find this information in the reports that were mentioned in the previous point.
In Nigerian conditions, for many technology/Internet investment projects, this sort of benchmarking is practically impossible because there is really no data about similar transactions. Often because these sorts of ventures are unprecedented.
So what to do if we don’t have such information? Well, one needs to base the pricing on the data that is available, as you will see.
B. Calculating the reconstruction value – what you did
This is actually simple:
How much time did you devote to your startup? Multiply this by the reasonable hourly rate.
What value did you create? Documentation, drafts, graphic projects, prototypes? Price these by using the market rate , as if you outsourced that (it is good to have some offers from independent companies).
Maybe you signed some preliminary agreements? how much they can give you?
C. Calculating the “speculation” value – DCF
- Write down all of the products/services you intend to sell.
- Think about how you want to sell it, how you are going to market it, how your sales will grow.
- Forecast the revenues on the basis of that.
- Write down all the costs you plan – salaries, operational costs, etc.
- Make forecast for 3 years ahead
- Check to see if you make a profit
- While forecasting – look carefully how your forecasts relate to the market size and the its growth dynamics – make modest
- If you make a profit, ask your accountant friend to calculate DCF on the basis of that.
The next thing is quite simple. To settle the differences, we calculate the arithmetic means from B and C, and this becomes the reference point in negotiations.
Personally I always tell the investor that this is my approach to business pricing where there is no data about similar transactions. I also remark that I will be happy to describe my approach. This is actually what this thing is all about — to get to the negotiating stage, isn’t it?