How Do Investors Set Business Valuations for Companies?

Investors care about business valuations just as much as the company itself cares. It’s important for both sides of the coin to have a solid understanding and respect for how a business is valued. Smart business owners should know their business inside and out, and smart investors should be weighing the opportunities and risks of any potential investment. Across the board, investors are seeing a general slowdown and a return to heavily focusing on valuations. We’ve actually been seeing a 25%-30% drop in valuations at the seed stage. That all comes down to business valuations. 

Know Your Worth

If you are looking to raise capital for your startup, regardless of the industry, you must have an idea of what your company is worth. It helps you be a smarter business leader, and it also answers questions from investors before they even have to ask. You can find free data from sites like AngelList or Pitchbook to help you get started. 

Startups Are Tricky

Startups especially are hard to value accurately, mainly because they don’t have operating income, or may not even have a go-to-market product yet. We all know there are a lot of costs that go into getting to market, and if you’re needing capital to start, it’s hard to know how to value your business when that product is not quite ready yet. Despite overall trends, this may mean you’ll get very different feedback on the valuation for your company from different firms.

Good Ideas Don’t Always Equate with High Value

Business valuation can be hard because if your idea is your baby, you may think it’s the next best thing since sliced bread. However, you also need a solid business to support your idea. If the basics of the business aren’t there for a profit, your idea may not be quite ready to be valued at what you “think” it is. It’s vital to leave your emotions at the door and approach your business valuation pragmatically. At the end of the day, you’re trying to build something much bigger, so getting hung up on small variations in valuation early on may not matter all that much.

Factors VC Investors will Consider:

Market Multiple: This is a common approach and is based on comparing the company against recent acquisitions of comparable/similar companies. It gives a good idea of what the market is willing to pay in any given season. VCs will use this mainly for doing competitive analysis to give them a good idea of what’s going on in your industry/type of company. However, if your company is a unicorn of an idea, it may be difficult to find comparables. 

Valuation by Stage: This approach is typically set by investors and is based on the venture’s stage of development. The further along a company is in development, the lower the risk and higher the value. 

As you consider the common approaches to business valuation above, you will notice flaws with each. None is truly a perfect way to set the value of a business. None truly embraces the unique solution each company brings to the table. So, it’s easy to see why there are so many intangibles that come into business investing that are often based on experience and knowledge of the industry. That’s a big reason why Sentiero focuses on tech companies utilizing AI and data. We know this space well; we know the opportunities, needs, and risks. We can bring a mathematical approach to how we value a business, but we also bring subjective factors into how we value an opportunity as well. It’s truly an art and a science!