How to value a start-up or small business
Ambitious owners of small, early-stage businesses who are looking at options for funding growth often ask: "How much is our business worth?" or "How much equity should we sell?" Gaynor Dykes, North West Growth Finance Manager at Grant Thornton, explains there’s no easy answer.
While there are all sorts of methods and formulae for valuing companies with a trading history, it is much more difficult when you're looking at a pre-revenue enterprise, or a small business with a potentially great product, but no customers yet.
The logical first step is to look around the market and research other businesses of a similar size, sector and potential, look at how they have grown, scaled and exited, and how they were valued.
Such a benchmarking exercise can be useful, but no business is ever the same, of course, and valuations vary wildly across sectors - just look at how some online platforms have been valued. Generally speaking, though, the earlier the stage of the company in its growth cycle, the harder it is to value it.
Having an honest conversation with founders is essential at this early stage too. Our advice is often about trying to change their mind-set away from "giving away" a stake in their business to "selling" a percentage in return for funding and usually also additional expertise that will provide the foundations for the business to grow and scale far quicker. Different ideas, as well as new equity, can be a real game-changer and can supercharge the growth of a company.
Advisers have an important role to play between the entrepreneur and the investor, particularly if this is the first time they have looked to raise finance. It's almost a mentoring/coaching role, where you try to highlight that dealing with investors is a negotiation – it’s a business deal at the end of the day – and you have to try and manage the personal emotions that can distract from closing a potentially good deal for all parties.
There needs to be some understanding, too, of the investors' position – investing in start-up and early stage businesses is risky – it’s a high-risk asset class – and investee companies should expect rigorous questioning of their business plan and strategy.
Another important point in this area of raising finance is to be open-minded. For instance, we encourage our small business clients to get out and meet potential investors and to understand that there are different types. Some will want to be really hands-on, while others will be prepared to take a back seat. Finding the right investor is key – you need to share the same goals and ambitions, otherwise the relationship can go wrong very quickly.
Our golden rules for fundraising:
- Be prepared to negotiate.
- Have some evidence of how you have come to the valuation of your business.
- Don't do it alone - take advice - and don't rush in.
- Don't forget the day job - raising finance can be a lengthy and distracting process.
Grant Thornton is one of the world’s largest professional services network of independent accounting and consulting member firms which provide assurance, tax and advisory services to privately held businesses, public interest entities, and public-sector entities.