Valuation with no revenue

[jasaunders]

I am at the beginning phases of soliciting investments for a venture and looking for thoughts and ideas about a valuation at the start-up before revenue.

I have read a decent amount on valuation methods before revenue, but haven't really seen anything useful. I would love to use my projected revenues, but I'm not sure if that is accurate enough and more importantly if the private investors I am pitching will be willing to agree/pay at that valuation.

Any information or if you can point me to some good references that can help me make a valuation, would be greatly appreciated. Or better yet, an open and friendly discussion on the pros and cons of different valuation methods would be even better.

- Josh

[David Rocci]

Josh, you should pick up Guerilla Financing by Jay Conrad Levinson (the same author as Guerilla Marketing). He talks about many early-stage and pre-launch techniques for creating value in a no-revenue business.

I've personally been in 5 presentations to VC companies and angel investors in the last 6 months - from New York to Chicago, Indianapolis and Michigan. Pro forma estimates and projected revenues are only a small fraction of their consideration. It's important to have a fully loaded pro forma month by month for the first 12 months, then annual ones up to 5 years.

Clearly define your exit strategy and break-even analysis. How many customers per month or top line sales dollars will it take to break even. Do you plan for a buy-out or ipo? Investors want to know how to cash in their equity and make their huge returns.

How much money are you seeking? Do you have any intellectual property? patents, websites, proprietary algorithms, equipment, processes? What's the general sense of your business idea so I can brainstorm in a more focused manner.

-dr

[jasaunders]

I will not be approaching angels or VC. I will be going after private investors that include people I know and other contacts.
I have a fairly detailed budget and revenue projections for 2 years, including different risk/probability models (conservative, moderate and liberal scenarios). At a minimum to get started I need to raise about $300,000, ideally I would like to raise $900,000. I will also be working on getting prepayments from customers to lower some of these initial investment costs if possible.

I am meeting with an attorney next week; it has taken a bit to find one because the field is pretty specialized that I need, especially in my location. I don't think their are any IP/patent that is associated with my business, but I am not sure and that is why I am talking to a lawyer about it first.

There is no exit strategy for myself or investors. I will probably be setting up the company to pay dividends to investors once the company becomes profitable. At this point, it is hard for me to see a need a few years from now to need an IPO or other financing given the exponential revenue growth and increasing margins I forsee with this venture.

[jasaunders]

No ideas or responses?
...ok

[David Rocci]

It's a little challenging to provide any specific assistance without an iota of information about your business. Pre-launch valuation is challenging and leaves room for interpretation.

For example, in our business that has no revenue (diabco life sciences) we spoke to an investor that helped steer us into appropriately valuing our business because we were undervaluing it. We paid $xxk for our website and have a wealth of content on there – if someone were to come in buy a fully working site with all the content already prepared, it’s worth something. We have a net 90 credit line with a supplier for almost $1M – that’s worth something…. But how much? We have a patent pending, but not an official patent just yet – that’s worth something…. But how much? We have price protection, customer protection and the licensed use of other patents from our ingredient suppliers – that’s worth something… but how much?

After everything was said and done, we increased our valuation from $2.5M to $12.5M. We worked with an investor and our outside accounting firm to agree on numbers that made sense and that they would stand behind. In accounting terms, these values are a number on one side of the ledger and don’t technically have any real value until someone pays for them. But it’s still a legitimate way to bolster the balance sheet.

Guerilla Financing provides that type of keen insight into finding value in places you may not have already looked in your business. It’s not a textbook valuation method but it works.

Hope this helps a little more...

-dr

[jasaunders]

I wasn't looking for anything specific for my case or any number from anyone.

I am more looking for some discussion on methods of valuation. For example the legitimacy of using revenue projections with some factor as opposed to using a discount rate factor based on a 5 year estimated valuation... or any other common or not so common methods of valuation for new start-ups.

[akula]

well...ok...there's one thing
every investor has a their own preferred valuation method
for example, I know through surveys that 70% of NVCA members adopt the NVCA DCF method...and this method changes from year to year

so you see, even members of NVCA differ on what methods they adopt...let alone all those angels or corporate venturers...and things become even more complicated if the company is doing an ESOP, 'caus then, the valuation has to be SEC compliant as well.....

so yeah man...in my experience, it helps to ask the investor about their preferred method, and go from there...I mean, the pre-money val is something that gets discussed way after the 4th/5th meeting, so there's plenty of time to the necessary discussions

like, with studentface, we needed to put a valuation on a prerevenue startup, but it had nothing to do with sales forecasts or discount rates...we just said, "this is how much money we need to make th company sucessful, and if you can give us this money, you'll get 51%"..and the financiers were totally ok with this way of doing things...they only had a certain amount of money they wanted to spend on the project, and they needed to take the majority interest...and so, in this case, the premoney val wouldn't have made a difference anyway

[jasaunders]

Thanks for the response.

The problem I see is that I am probably going to need/have 5-10 investors minimum, and so I want to approach all potential investors with a consistent message, valuation and offer. I don't want to go to someone one day and sell them a 5% stake for $50,000 and the next day go to a different investor and offer a 5% stake for $20,000. In fact, from some reading I have done, I think under certain circumstances it can become illegal to sell shares for wildly different amounts to different people within some timeframe.

I think the fact that I will be approaching smaller private investors gives me more control and say over the situation and valuation. They won't be professional investors and so won't know what to ask for or be in control as much as an angel or VC firm would be.

I am trying to minimize the number of investors. I am setting the minimum investment at $25,000 to help, and hoping I can get a few larger investments.

I'm just trying to think this through in the back of my head right now as I approach potential customers to get some pre-sales. And then if I can get a significant amount of pre-sales, balancing the risk of taking too many against the amount of initial investment I need. There is some risk in my model in taking too many pre-sales; if something were to go wrong and I wouldn't be able to deliver to those customers, but they have already paid. They are buying a service, not equity, so there could be major implications there. Obviously, it would be a great problem to have though if I had too many pre-sales coming in.

[Cole Taylor]

$300,000 should be attainable from family, friends, and friends of friends. The good news is you dont have to be ultra sophisticated and dont even really need a pre-money valuation. My preferred method with dollar amounts in this range is secured convertible debentures.

In fact, keep things as simple as possible. More than likely they dont know what a pre money valuation is anyway. All they look at is how much they can make which is based on your EPS* # shares. Dillution is what matters to the small guy and your PMV is generally based on the amount of money you need, nothing else.

Stay away from guys that use term sheets even the angel groups. If you need a ballpark you could always discount cash flow at exit at a ridiculous 50-70% discount.

[jasaunders]

Most of my money will be from family, friends, and friend's friends.

I really don't want to take on much debt financing with this company. It is a go big or go home type venture, and I would prefer to keep it to equity investments.

Now it is likely they won't know what a PMV is. I am thinking they may not be very knowledgable in general with their investments. So it would be easy for me to go in an say I think the company is worth $1.9M based on 1st year revenue projections, so if you invest $100k, you will get 5% of the shares. Or likewise with a discount rate, say the expected company valuation in 5 years is $95M, and with a discount factor of 50, the company is worth $1.9M (and a $100k investment would get 5% of the shares).
Basically, using the discount rate I could make the number whatever I want because several years down the road is extremely unpredictable (even more so than 1 year).

[Cole Taylor]

Just keep in mind that with the debt you can build in any contingencies you want, i.e. forced conversion based on certain milestones, revenues, etc. You may even end up making so much that you want a bigger piece of the pie and cash out your investors (callable).

The arrangements can be as simple or as complicated as you want. One thing I've found is that it's easy to say "look you're getting 15% no matter what. You decide prior to the maturity date whether or not you want to own the underlying stock...That's where the real money's made."

If you do end up selling stock, I'd at minimum put together a 504/505/506 Reg. D PPM just to protect yourself. If you're only selling in your home state it's real simple. After you make your first sale, within 15 days, file your form D with the SEC and any state filings.

Make sure you personally know any non-accreds. Although most registrations will allow you to sell stock up to 35 non accredited investors, it's the non accredited people that will cause you all the problems.

Good Luck!

[jasaunders]

Thanks for the info and advice.
I will be discussing all the legal issues including investments from non-accredited investors with a transactional lawyer beforehand and have all paperwork and operating agreements done by this lawyer.

I understand the benefits of the convertible bonds. The problem I have with it is taking on the debt and having to repay if things don't go as planned. I can't really afford that financial risk. The financial risk I would already be taking is quitting my job and working super full-time to get this going, which is a fairly decent amount considering the opportunity cost. It would be nice to have a callable bond, especially if things go well; but I think at this point I would rather give the equity to lower my financial risk (which also obviously limits my potential financial gain). But I will definately keep this in mind.

[akula]

so how's it looking?
is there anything else to discuss in this thread?

[jasaunders]

I don't know. Any other ideas about valuation methods?

I'll probably pretty much just pick a number based off my projections, and I'm leaning towards $1.9M.

[BusinessAdviser]

Either way, you need to have a projected cash flow. I always advise a most-likely number, a very conservative number, and a we're-kicking-ass number. You'll figure these for, say, 5 years out. Then use the Capital Asset Pricing Model, using comparable companies, to find the discount rate. Then, apply that rate to find the present value of the stream. This will all require forecasted revenues, costs, yada yada yada...everything. If you were using any debt, you'd need to find the weighted average cost of capital model. Once you have those, you have 3 values to approach investors with: a likely value, a conservative value, and a promising value, and you will be able to support your valuation and thus their investment. Any questions?