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Slide 12: Capital and Valuation
This slide presents your request for capital and proposed valuation of the business. In the Financial Projection chapter we explained the different methods for valuing the business. You will need to propose an anticipated value for your business when asking investors to purchase equity. (Note: Some investors say that the entrepreneur should not state the valuation, as projections are often inflated and valuation is the job of the investor.)
Presenting the Valuation
The business valuation is primarily drawn from the expected revenue of the business at the time of exit. Your slides should provide the following information about your businesses revenue and valuation:
- Projected Revenue
- Industry/Transaction Comps
- Compare against DCF
- Ask for the Money
The projected revenue should mirror the information (particularly the revenue assumptions) stated in the financial projections slide. For example:
$20 x 100K persons (.5% of market) = $2M (Revenue at Year 5)
After stating your projected revenue at the time of exit, you should state a proposed value of your business. The most common method is to identify comparable valuations for similar deal sizes (similar revenue) or for similar businesses within your area (scaled up or down to fit your revenue projections). The discounted cash flow method is the least used method by angel investors, but is the dominant method among Venture Capitalists. If you are seeking early stage money, then it will likely be from an angel investor. If, later in the development of the business, you seek venture capital funding, you should rely primarily on the discounted cash flow method.
Example of Valuation Calculation
In the scenario above, you are projecting revenue of $2 million at year 5. If your business has a valuation multiple of 5x (5 times) earnings, then the value of the business at the time of exit will be $10 million. You are asking for $250,000 worth of equity investment from the angel investor. The investor will want to receive anywhere from 10x to 30x the amount of money invested at the time of exit. Let’s say, the investor is intent upon receiving 20x money invested. This means that the investor will need to receive $5 million at the time of exit. This means the investor will want 50% of your business for this type of investment. This means that the investor assumes that the business has a post-money valuation of $500,000 and and Pre-money valuation of $250,000.
$2M x 5 = $10M (at exit)
Required Capital = $250K
Investor Return = 20x or $5M
$5M / $10M = 50% of the Business
Pre-money = $250K, Post-Money = $500K
Now, if your financial projections and timeline indicate that you can achieve your business milestones without the need of more outside cash, then you can deduce the investor’s percentage as stated above.
In many cases the investor will assume that you will have to raise more equity financing at later points in the business. The issuing of more shares in these later rounds will dilute the original shares of the investor. In this case, the investor will want certain protections in the equity purchase agreement to protect him or her against dilution. However, even with these protective provision in place, the investor will still face the risk of dilution caused by overbearing later investors. The later investors will sometimes withhold financing unless the angel agrees to be diluted. So, the initial valuation will often require adjustment in the percentage of equity purchased to protect the investor’s interest.