How to Determine Your Company’s Valuation
If you plan to offer an equity offering via crowdfund investing, you have to calculate your valuation. Valuation is a topic covered in depth in many academic books and college courses. Why is valuation important? Without knowing how much your business is worth, you can’t know how much its equity is worth.
You don’t want to inflate your valuation in an effort to impress potential investors. Crowdfund investing is built on trust; people who know you (or know about you) are putting their money into your business because they believe in you, your idea, and the business opportunity. If you want their support, you have to be reasonable, honest, and transparent.
If you run an existing small business and don’t want to hire someone to help you calculate the value, then back to Excel with you! If you choose File→New from Template and enter “Valuation” in the search box, you should see a template called “Small Business Valuation.”
Using this template, you simply look at your company’s profit and loss statement for the year and enter those values in the cells. A valuation will be calculated at the bottom based on industry standards. (Note: You can change the valuation, but be prepared to defend why you do.) The beauty about using this Excel function is that you can tell anyone who asks exactly where you got it and share the form with her.
Calculating a startup’s value may seem a lot trickier, but you can (and should) try to keep it simple. Think of the key components it takes to launch a business: funds to cover the hard costs of getting the business up and running, and people to do the job.
For this reason, human resources are worth more than cash or goods. When you approach the valuation of your business, don’t undersell the value of your ability to execute your plan.
Start your valuation process by summing up all your business expenses. This money represents one portion of the total value of your startup. The other portion is your time and your ability to execute your plan. (If you’re working with a team, the entire team’s time and ability factor in.)
Here’s how you may present your valuation estimate to your investors:
“I’m trying to raise $100,000 to cover startup expenses. I think that money is 20 percent of the key to success. My passion, commitment, dedication, and ability to execute the plan make up the other 80 percent. Hence, the value of my business is $500,000.”
The beauty of doing a startup valuation this way is that it’s subjective, easy to understand, and easy to negotiate. When you socialize your idea with your friends (and eventual backers), they may say, “Are you kidding? That $100,000 is worth more than 20 percent.”
You can talk it out and adjust your figures based on crowd feedback. But remember not to set too high a valuation or you may inflate your funding target. And never set such a low valuation that the amount of equity funds you raise is equal to or more than 50 percent of your business! If you do so, you lose control of the business you’ve worked so hard to create.
Is it possible to get more sophisticated about valuation? Sure. Doing so requires hiring someone who can create detailed financials and understands valuation methodologies that are based on multiples of sales, multiples of earnings, discounted cash flows, assets, and so on. But as long as you’re realistic and willing to discuss your valuation estimate with your crowd, you shouldn’t need to spend the money to go this route.