How Angel Investors Arrive At Valuations

13 April, 2012

Hardly a week goes by when I don't have entrepreneurs calling me about valuations before they are ready to raise their round. By that time, they already have some angel interest and two or maybe three investors have agreed to fund the venture. However, they cannot agree on valuations. Valuing companies, at any stage, is an art. And at the earliest stages, it is even more difficult. No two start-ups (regardless of how similar they are) are going to be valued the same, given specific factors such as revenues, customers, sign-ups, etc. or nebulous ones like traction and experience of the team. Here are some of the mechanisms and examples we have seen for recent valuations.

Based on projections: A start-up we recently helped fund had two seasoned executives from the hotel industry who were looking to launch a new boutique hotel. They were the GM and the revenue manager of a well-known chain (150 keys) before they decided to plunge into entrepreneurship. They had four-year projections, scoped out land (joint venture) and agreed-on terms with a bank for a loan of up to Rs 2 crore.

PowerPoint and experience were all they had. If you are in this situation (great track record and proven prior success in the same industry), valuations tend to be based on how much they will do in 3-4 years and how much will the company be valued at that time.

The investors looked at their projections, shared their expectations for return (22 per cent annual) and applied a 'risk factor' to their projections (which were independently verified). So, percentage ownership was determined at the value of the company four years hence and the value of the ownership at that time, inclusive of the minimum expected return. The investment was valued at Rs 4 crore.

Based on the amount you are looking to raise: Generalising it quite a bit, of the few angel investors we have worked with, they look for 10-15 per cent stake and usually a 2-4 times return in an average of two years. (I know that's high, but many claim to get that from other sources). And VC's typically expect to own 30-40 per cent (or more in certain cases). So let us assume that you need Rs 2 crore (about $500K) and you have three angel investors, each going to put about $167K. Then your pre-money valuation at 15 per cent to the angel investors is about $2.8 million and $3.3 million post-money. We have seen 2-3 companies go with this model for valuing companies.

Based on current revenue, GMV or profit: E-commerce companies (recent) with some traction (daily transactions, website running, shipping product to customers) are increasingly using GMV (Gross Merchandise Value) or the total value of all goods sold as their benchmark for valuation. In most cases, these companies have fewer than 10 people in the company, are doing about 20-50 transactions per day and GMV of about Rs 1-2 crore (run rate). They are being given between 2 and 2.5 times GMV as their valuation. We have also seen two companies get more than three times, given that their CEO was from the vertical industry and is a well-known expert in the field.

Based on known public market: Using publicly held companies as benchmarks and within their industry, looking at metrics such as sales, profit & market capitalisation, you can arrive at numbers that give you a fair idea. We have seen two or three small-to-mid-sized IT services companies which have used this model to come up with valuations (usually 1 to 1.8 times sales). And it is the same for restaurants (1.2 to 1.4 times revenues).

There are many other mechanisms, but you get a general feel for the numbers, given the above methods currently in vogue.

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How Angel Investors Arrive At Valuations

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