There is a lot of confusion around the V word in businesses. Lot of deals fail only because all the parties cannot come on terms with valuation. The reason for this unsettlement is because there are no fixed formulas to arrive at business valuations. There is no precise methodology to do so, but only some parameters which we have learnt to apply through our experience in the Private Equity & Investment arena. The factors which drive the value of a company largely varies based on the nature of business and it is imperative to understand these factors before either investing in a company or asking for an investment.
Valuation of a business is not stagnant for a long time as there is always new information, verticals and revenue stream being introduced by the team. However, it is observed that, founders are not always realistic while valuing their enterprise. Commanding higher valuation is not a big deal as long as you are able to practically justify the valuation .The valuers should attempt to put themselves in the shoes of the investor and then decide on a number which is pragmatic. A pre-revenue company, in a fairly explored area, without adding any value in technology or otherwise, claiming a valuation of 150 Crores and wanting to raise 20 crores in their seed round is unrealistic. ( I am not even kidding! This is an actual instance).
There are a lot of proven methodologies which have been used by investors to determine the valuation of a company. Where a recent investment is being made in the company seeking investment, the pricing done for that investment shall provide basis for valuation. Investors also derive the valuation based on the milestones achieved by the company. Some of the milestones are elaborated below:
In case where the company has had identifiable strum of continued earnings, which can be maintained a multiple is applied to the earnings, in order to arrive at a value. This multiple needs to be reasonable and appropriate and should take into consideration the risk profile and earnings growth prospects.
Investors have also chosen to rely on the net assets of the company, where values are driven mainly from underlying fair value of its assets instead of the company’s earnings.
Specified industries may have their own specific valuation benchmarks. This is considered to be reliable while estimating the value of a business.
Ultimately, valuation is something that needs to be proven to the investors and not asked for. We therefore tell our Entrepreneurs, don’t demand higher valuations, command them.