The pre-money valuation is extremely significant information for a company seeking to raise capital. One of the obstacles that equity crowdfunding has had to face since its inception in 2013 until today is the investors' skepticism towards the combination of emerging startups and online transactions. This skepticism has not completely dissipated, but it has been mitigated by the adoption of precise and stringent rules and the availability of transparent and mandatory information about companies launching online equity crowdfunding campaigns. Among this information, pre-money valuation is crucial.
We are talking about a key fact: an accurate estimate of a company's value before a financing round is most important for both the company itself and potential investors. It is the basis for building a relationship of trust and for making exchanges and deals that are fair and profitable for both parties.
That is why we decided to delve into this topic together with Equidam, a startup valuation tool, which provides valuable insights into key data for making and motivating a reliable pre-money valuation.
Why pre-money valuation is important
La pre-money valuation is a snapshot of the starting point a company is at before a capital raising: it is an economic value, however, representing not only concrete economic data, such as share capital and profits (which for startups often do not yet exist), but also future economic prospects, resources, strengths, etc.
The result is an indicator of the company's reliability and potential, which is particularly important in online transactions, which require even more transparency than offline transactions because communication is asynchronous. On the pre-money valuation, moreover, depends the subscription price at which the company's shares are offered in equity crowdfunding.
Presenting your offer clearly and accurately and being able to justify the pre-money valuation in a precise and transparent manner is crucial to come across as convincing and reliable with investors and not miss any opportunities.
Where to start: comparable data
A useful starting point for pre-money valuation is to compare with other startups or companies similar to yours. Crowdfunding platforms are a convenient database of publicly released company valuations. It is a good way to familiarize yourself with this process and see if your expectations are in line with the market.
Useful data come from startups similar to yours as level of risk and expected return, so the search criteria should be as follows:
- recent campaign to ensure that market conditions are similar;
- startups at the same stage in terms of employees, product development stage, traction and brand strength.
- startups with similar growth potential in their respective market.
In addition to going directly to the platforms, you can also consult major databases on startups that already aggregate the information you need, for example Crunchbase or Dealroom. To get really useful results, you should collect an amount of data that is neither too narrow nor too broad, so that you get a sensible average and exclude irrelevant and exceptional data.
That is why it is not useful, however, to refer to news about startups conveyed by news outlets, especially those specializing in tech, because the companies that make the news are often above average, so their valuation may be inflated.
This part of the process will help you adjust your expectations of the evaluation and provide examples and context for defending it to potential investors later.
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How to calculate the pre-money valuation
Calculating the company's valuation is a learning experience for founders because it forces them to thoroughly examine goals, strategies, resources, processes, teams, and financial projections, and to check for consistency among them.
Financial projections for an early-stage startup may seem particularly challenging and perhaps unremarkable, but it is a useful exercise for the future. Here are some useful tips on how to do it.
Most potential investors in an equity crowdfunding campaign will be retail (or nonprofessional, or unsophisticated) and will therefore have varying levels of understanding of valuation metrics, but they all share with professionals the goal of closing a good deal. Therefore, a two-pronged approach is needed to succeed in communicating with all stakeholders:
1) a robust methodology based on rigorous benchmark industry standards (there is no single universal calculation method, rather there are several, to be selected based on the life stage of the startup and possibly combined with each other);
2) a detailed and transparent report that specifies the sources and explains the calculations that led to the data.
In order to figure out which calculation method is the best fit for your startup and reduce the time it takes to carry out the valuation, it is useful to rely on professional consulting or use a special tool, especially if your in-house team does not have experience in this area. If you choose a consulting route, it is important to make sure you are dealing with startup experts, because valuing a startup is quite different from valuing a more traditional company.
Collect feedback on pre-money valuation
The first useful opinion on your pre-money valuation may be that of the crowdfunding platform itself. Their interests are totally aligned with yours in the sense that they want to close the campaign successfully, with good results for both sides. They have seen so many companies and so many evaluations, so they can share their input and possibly even connect you with mentors and evaluation experts. Attention, though: be aware that some platforms may have a tendency to lower the valuation slightly in order to offer more solid returns to investors.
Feedback from friends, other founders, and experts in the field can also be valuable. All can help you test the assumptions built into your evaluation and shed light on aspects you had not considered.
Finally, more subtle but very significant can be feedback from professional investors or even non-professional investors but with some day-to-day investment experience. These are people who evaluate deals on a regular basis and always have an idea of what is going on in the market, the price at which deals are closed, and the buyer-side opinions and motivations.
Risks and mistakes to avoid
The pre-money valuation must be accurate because both overestimation and underestimation can be very harmful to the company as well as to investors.
It may not be immediately intuitive, but raising crowdfunding capital at unreasonably high valuations can create enormous problems for several reasons. Chief among them is that if you are forced to move to a lower valuation in the next funding round, you will make a bad impression on the investors who backed you, who may even be some of your most loyal customers. You will lose credibility and come across as unreliable.
But the same applies to too low a pre-money valuation: in addition to having the effect of such a loss of credibility and reputation, it exposes the risk of excessive share dilution.
That is why it is important to devote the right time and resources to pre-money valuation, ask for feedback from your network, and learn from the experience of other startups.
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