Understanding Startup Valuations: How to Determine a Fair Price Before Investing | TFJP 92

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welcome to the founders Journey podcast

inspiration education for Founders by

Founders hi am Greg Moran from Evergreen

Mountain Equity partners and the

founders Collective one of the trickiest

aspects of Angel Investing is

understanding how to value a startup

it’s something that you know even

professional investors wrestle with all

the time because you’re earlier Stage

Company just the more subjective it

really becomes there’s no real clear

earnings history or stable cash flow so

valuing a startup can really be like a

guessing game in today’s video I’m going

to guide you through some of the most

common startup valuation methods so in

tips we’re going to get into tips for

evaluating fair value and ways to

negotiate terms that make sense for both

you and the founders and help you avoid

some of the common mistakes that occur

when you’re trying to invest in early

stage company so by the end of this

you’re going to have a strong foundation

for assessing valuations in your own

Investments let’s start here unlike

really established companies startups

don’t have a stable Revenue stream they

may have Revenue but it’s not

necessarily something that you can

really rely on in many cases or it’s

very new or and they’re just really it’s

not a scalable really predictive Revenue

stream in many cases let alone profits

which which you know rarely if ever are

they going to have any early stage

valuations are essentially trying to

predict future potential than than

actually measuring current performance

which makes it really difficult this and

it also what it does is it makes it

really subjetive so startup valuation

methods really usually rely on

assumptions about growth potential about

the market opportunity and about the

quality of the founder and the team

which are really kind of Paramount to

when you’re looking at trying to assess

what is the long-term potential of this

company and and and your investment so

when done well though valuation really

helps align a founder and an investor

around the expectations and really what

it does it allows both parties to set

terms that are mutually beneficial and

helps the company in the long run to

scale whether that’s you know bring out

enough Capital bringing in future

Capital things like that these become

really important areas where that early

stage valuation has a lot of Downstream

impacts that um you know without if you

don’t have experience you are hard to

see coming sometimes many Founders don’t

really understand that and really just

look at it as the highest valuation I

could possibly get as the best one and

that’s often not the case at all let’s

get into some of the ways to look at

valuation of early stage startups one

popular method is the comparable company

analysis or what’s called a CCA so what

this does is it looks at valuations of

similar companies in the same industry

and stage now oftentimes you may if

you’re making investments in technology

you know there’s usually a track record

you can follow there’s you know it’s

Healthcare Tech or it’s fintech or

something like that and by comparing

recent investments in similar startups

you start to get a ballpark valuation

for the Target company now things can

move but it will put you within a

reasonable radius of knowing if you’re

in the right uh if you’re right in the

area so you know give you an example if

you’re looking at Health Tech startup

that’s really early stage you can check

recent valuations for other Healthcare

or other health Tech companies that are

at similar stages look at the ranges of

those valuations that’s going to give

you a good ballpark to start your

negotiation so some pros and cons here

CCA it’s really straightforward it

provides Market based valuation so it’s

a pretty easy standard method to get a

to get a range but downside is it can be

challenging to find comparable companies

especially if your target startup has a

unique model or it operates in like a

really Niche sector sometimes the data

is just not really there to use as a

comparison you want to consider just

from a tip if you’re thinking about

using CCA as a as valuation method

consider the unique qualities of the

target startup as well compared to its

competitors getting those comps doesn’t

necessarily tell you the exact number or

the exact valuation because you do then

want to start to look at those

inequalities things like the experience

of the founder or the team the

technology scalability differentiation

things like that and then you can adjust

your valuation expectations uh

accordingly based on those things so the

second method that we’re going to talk

about is uh what’s called the burkus

method and this is really useful if

you’re dealing with a very early stage

startup so with burkus method does is it

assigns a value based on five core

factors Sound business idea like what’s

quality of the business idea the

Prototype is there one and what’s

quality of that the quality management

team like the quality of the management

team is it a strong management team

strategic relationships that maybe the

company has Partnerships um things like

that that give it a unique advantage and

then the product roll out so if the each

factor is given a monetary value

typically up to say

$500,000 right resulting in a maximum

pre-revenue valuation around two or

three million is kind of how you would

look at this right so it’s sort of

putting a cap on it saying okay we’re

going to Value each one of these five

factors at $500,000

and if we’ve really maxed out the scale

there we’re going to give it full value

of say the quality of the management

team for 500k maybe there aren’t a lot

of strategic relationships which is

another one of those factors and maybe

you’re not going to value that as highly

give but you end up if if all the

factors were maxed at you know around 2

to three million and you kind of go

downward from there based on what’s

occurred again this is a really helpful

way for pre-revenue companies where you

can’t value the revenue stream at all it

doesn’t uh it doesn’t exist the nice

part with the burkus method it’s really

easy to apply and it’s ideal for

startups that have no Financial history

at all right it just kind of brings some

objectivity to something pretty

subjective at that point uh the downside

really is because it is so subjective

you really have to look at each Factor’s

value and it’s really going to come down

to your judgment as an investor rather

than any kind of financial model it’s a

good approach though if you’re dealing

with a pre-revenue company but you got

to be realistic here you you really

avoid inflating values unless the

startup clearly meets or exceeds each

factor again I would sort of call it

objective subjectivity but it gives you

something to use for pre-revenue

Investments next one we’re going to talk

about is uh something you may be

familiar with discounted cash flow or

DCF method and this is much more suited

to later stage startups that have some

Revenue history so what this does is it

projects future cash flows and then

discounts them back to present value on

a risk adjusted rate DCF is actually

used in larger companies as well what

essentially what it does is it asks how

much is the company’s future Revenue

worth so what do I believe the future

revenue is going to be and then what’s

that Worth to me today to buy that

Revenue potential so give an example

because this can be kind of theoretical

if a startup is projecting 5 million in

Revenue in 5 years then what DCF does is

it helps calculate today’s value of that

Revenue

after accounting for risk let’s say we

think in 5 years that Revenue the

company’s going to be at 5 million well

there’s a lot of risk in getting to that

five million so what today do I believe

maybe if it did actually get to that

five million maybe be worth four times

that five million or something like that

but you’re obviously not going to pay

that today when you start to put in the

risk maybe that you know example of 5

million in 5 years times four right

multiple four on that 20 million but

maybe you think today like hey there’s

you know there’s probably only a 20%

chance they’re going to achieve that so

then you’re looking at you know

something like a $5 million valuation or

something like that right so different

ways to do this but again what you’re

looking at is what what do you believe

that future revenue is going to be in

some period of time what DCF does is it

provides a really detailed quantitative

valuation you can use the company’s own

financial model if you believe the

company’s financial model to be true

that’s also the downside it requires

really solid projections you have to

believe them and this is why it’s often

used for later stage startups because

early stage startups often don’t have

reliable projections their guesses and

those things those guesses then become

really highly sensitive to that whatever

discount rate you’re going to apply so

the more reliable Revenue history exists

the more DCF uh becomes a really good

way so if you’re investing in really

early stage startups use it cautiously

if the Revenue projections seem overly

optimistic or assumptions really feel

shaky or there’s just not a history to

go on to know if these things are

realistic at all if you’re going to use

DCF you want to make sure Founders are

using a conservative scenario or you may

just want to use another another method

The Venture Capital method this is

something that we use as well as a at

Evergreen Mountain Equity Partners

Venture Capital firm it’s popular among

early stage investors and it’s based on

target returns okay so this is something

that we one of the ways that uh that we

value companies so first we’re going to

look at what do we believe the exit

value is what’s the potential of that

exit value so the potential value at the

time of sale or IPO or whatever we use

our own exit value right not not

necessarily we’re early stage investors

we may not be in it until IPO or

something like that so we’re looking at

what do we believe the exit value is to

us then we kind of work backward to

really calculate today’s value based on

that Target return so let’s say if we

want a 10x return and we believe the

company could exit at a 100 million in

five years 10 years seven years whatever

it is today’s pre-money valuation would

be 10 million right 10x return 100

million 10 into 100 million $10 million

would give us the uh will give us that

potential of a 10x return at 100

million so again one way to do it the

nice part is it aligns with the expected

returns which makes it really attractive

to investors but the downside is it

relies on a really speculative exit

value and it could be overly optimistic

if market conditions really change along

the way which again our hold periods can

be you know five years or more so you

will have Market Cycles in there which

means you you know you really want to be

able to get your exits when the market

is uh is at its best so when you use the

the VC method you want to really ensure

that the exit assumptions are realistic

right what do we really believe that

this could be and then you want to

validate that exit value based on

similar companies that have successfully

exited so this is where you start to

kind of combine it with that CCA model

right look at other companies what did

they exit for is the assumed valuation

that you’re using on exit realistic if

nobody has ever exited in this space for

more than a 100 million there’s probably

not a good factual basis to believe

you’re going to exit for a billion so

just things to look at the last one I

want to talk about is is a little bit

different right because the valuation

methods that I all talked about are

focused on numbers but the thing that it

doesn’t account for is the quality of

the founder and the critical role that

the quality of the founder plays in

valuation especially in early stage

companies gets less important as a

company gets more mature but at an early

stage it’s it’s really key a great

founder can increase the likelihood of

success and improve the company’s

valuation over time there’s

no doubt it’s often one of the top if

not the top determinants of the future

value of a company so at Evergreen

Mountain Equity Partners we’ve got we

built a proprietary founder assessment

that really evaluates essential traits

like resilience adaptability strategic

accountability and other ones because we

really believe that Founders who

demonstrate these traits are much better

positions to navigate challenges and

grow the company which has a huge

outsized impact on the long-term

valuation a Founder with a really strong

track record and the right qualities can

justify a higher valuation we will pay a

premium for that if we have a lot of

conviction around the ability of this

founder conversely if we think that the

founder lacks these qualities we

probably won’t invest or maybe they do

have these qualities but they don’t have

experience we may negotiate a little bit

lower valuation because the risk is a

little bit higher before we close out I

want to talk real quickly about just

some tips on negotiating a fair value

valuation so once you’ve determined a

reasonable valuation range it then comes

down to negotiation so here’s a few tips

to really keep in mind one you got to be

transparent share your valuation

assumptions with the founder and talk it

through what it’s going to do is it’s

going to build trust it’s going to build

a collaborative approach when you arrive

at these numbers quite frankly you know

people get really carried away with with

negotiating valuations in an early stage

company a million two million in either

direction is not going to make a

long-term difference to to your return

really share the assumptions that you’re

using in your valuation to make sure

that there’s alignment between you and

the uh you and the founder the next tip

is you want to really highlight risks

and the adjustments you’re using so if

you believe that the startup has a

higher that has higher than average

risks maybe you believe that there’s

regulatory challenges things like that

you want to really Factor these into the

to the valuation again be honest be

transparent with the founder when you’re

going through this third you want to

consider non-monetary terms if you can’t

agree on Val valuation what you can do

is propose other Equity like based

compensation or Milestone based tranches

that align with your risk tolerance this

is something that we have done a lot at

Evergreen where maybe the founders

looking for a much higher price than we

are willing to pay at that point what we

have done uh and we routinely do this is

then structure it to say okay we’ll

invest less today and if you go hit

these Milestones we’ll give you the

number the price you’re looking for with

a second trun or something like that so

you can stage these things out a little

bit as well and put some proof in there

uh to make sure that you know the

founder is able to go and execute along

the uh to to support a higher valuation

if they do great pay the higher

valuation negotiation doesn’t always

mean just lowering the price sometimes

it’s it’s about structuring the

investment in a way that really aligns

interests and mitigates risks to wrap it

up you know startup valuation is part

art it’s part science it’s definitely

more art than science um but by

understanding these methods like

comparable company analysis the Buras

method DCF the VC method they give you

some tools to use in your toolbox to be

better equipped to assess the fair value

of a company remember a great founder

can add value well beyond the numbers

which is why we at Evergreen Mountain

prioritize founder selection and the

assessment of Founders in our evaluation

so if you’re interested exploring more

about about startup investing learning

more about valuation strategies or our

unique approach to founder assessment at

Evergreen Mountain Equity Partners or

adding Venture Capital earlier stage

investing seed level stage investing in

a diversified portfolio as part of your

asset uh allocation strategy reach out

to us go to

.io we’d love to talk to you discuss how

we can support your investment goals and

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