Difficulty of valuing an early stage company

How difficult is it to value an early stage company?

An early stage company often needs to be valued; it will certainly be part of the process of getting investment on board. The big problem, however, is the lack of a track record and decent forecast information.

It’s interesting to illustrate how this impacts on valuation, by considering 3 of the main methods an investor might use to value such a business:

1. Discounted Cash Flow This is difficult to use in practice as it’s too dependent on the terminal valuation (the exit price) of the business. Also, the certainty around forecast data decays the further out one goes. Nevertheless, it does have utility as a sanity check on other methodologies.

2. Comparative Multiples This is also known as the market method. Early stage investors rarely use it on the way in, because it’s difficult to find true comparatives. However they will often use it when making interim valuations of the portfolio investments.

3. Heuristic When the chips are down, many investors will value based on “what things are typically worth at this stage”. For seed stage only investments (of the type normally done under EIS or SEIS by Business Angels), this will be in the range of £200k – £1M. Alternatively, investors might consider what founder equity is left after their investment. Of course if they’re keen to invest, it could simply be “what gets the deal done”.

One size doesn’t fit all

In reality, valuation is more of an art than a science. There can be a number of different, yet each entirely justifiable valuations for the same business at the same time.

In order to pin down a realistic and comprehensive valuation then, it is imperative to take into consideration the:

  1. purpose of the valuation; nature of the business;
  2. trading environment; wider economy;
  3. feasibility of forecasts (if they are being used in the valuation);
  4. underlying quality of the information (upon which the valuation is to be based).

So what’s it really worth?

At some point you may need a full specialist valuation, but unfortunately many of these are done by accountants for whom this is not the ‘day job’.

As a result, you may end up getting a ‘cookie cutter’, ‘one-size-fits-all’ valuation. In contrast, we don’t use mechanistic form-filling or software driven results – our multi-disciplinary Valuations Team tailor the process to each company.

If you’d like an informal chat about valuing your business, over the phone or a cup of coffee, please get in touch.

Lake Falconer About the author

I head up PEM’s business valuation team providing valuations for shareholder exits, disputes, business planning, tax and accounting, and matrimonial disputes. In addition, I am a Partner in PEM Corporate Finance, a specialist team advising on management buy outs, corporate acquisitions and disposals, succession and strategic planning.

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