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Fundraising & Valuation - Art or a Science

Dilemma around Valuation : At an early stage, it becomes difficult to arrive at a perfect valuation. Though there are various methods of valuation, like venture capital method, Berkus method, Scorecard valuation method, NAV method, discounted cash flow method for early stage startups but they seem to be not the real solutions.

However, a well-articulated & realistic Business Plan or financial projections helps the startup arrive at a valuation. Sometimes in a startup since there is no historical data available of the startup, it is advisable to do a peer-to –peer comparison of a company of similar background, offering equivalent products or services and take a peep into their valuation at different stages. Accordingly, their own valuation can be arrived at.

There’s a Scorecard Method of valuing an early stage startup. It is the most preferred method used by angel investors. It uses the comparison of the startup with the perception of the other startups suing factors such as Robust Business Idea, Management Team, Market Size, Product/Technology, Funding needs & Scalability etc. It is highly subjective but the main emphasis (20%-30% of weightage) goes to the startup team of Founders. The next can be how unique and disruptive is the business idea. “In building a business, the quality of the team is paramount to success. A great team will fix early product flaws, but the reverse is not true.”

But, as emphasized earlier, the early stage valuations are difficult to make and are hence generally “Guesstimates”. A startup doesn’t have any historical data to show how they fared in the past. The startups talks only on the basis of EXCEL SHEET NUMBERS. Since there is no validation of numbers, the best method is to build a business plan which is broken into plausible steps or milestones and it is easier to be able to gauge the kind of funds the startup would require for fulfilling each milestone. The Fund requirement should be broken into Working Capital, Manpower, Marketing Branding & Customer Acquisition, Technology or Product, Capex etc. The investors would be happy to pick the cost that they want to invest into as per their mandates / investment thesis.

Confusion around Dilution: It is important for the founder to understand the concept of PRE-MONEY and POST MONEY VALUATION Concept to avoid any unnecessary dilution. PRE-MONEY refers to the valuation of the company before it receives the investment such as external funding or financing. The post money valuation of the startup refers to its value immediately after receiving the capital from the round of funding. This determines the equity share that investors are entitled to.

Problem around Fundraising : Even with the best approach, 90% of the startups in India fail to raise the funds. This is because of more than one reason .The metrics show that PRE-REVENUE stage startup don’t get funding easily as compared to the POST–REVENUE stage startups . To combat this it is best to bootstrap the venture till it reaches the revenue stage and the model is proven with a paying customer by its side. So it’s better to bootstrap and also explore all other funding possibilities, generate revenue, stabilize business model and then approach the investors for funding needs. With history of constant revenue generation, the business model is explained better. Surviving the pre-revenue model is enough proof that the startup is on its way to attract customer who are willing to pay for their business idea.

Another reason why the startups fail to get the attention of the investor is because of over declaration of the value of their startup. The founder must make a very well calculated and fair estimate of the value of company

The size of the opportunity also is a big deciding factor for the investors. The scalability of the business is an important factor. A business that is very niche means restricted revenue which may sometimes not interest the investor, that is the reason that B2C startups gets better attention from investors.

The rigidity on the part of the founder can be another reason for the investor to feel disinterested in the venture. There founder should be flexible and learn to discuss instead of arguing with the investors. It is important for the founder to show a very clear path of Return on Investment (ROI). It is important to share how the investment will accelerate the revenue, increase margins, reduce the resources used to generate revenue and keep scaling.

Pitch the Right Numbers: A Pitch is the visiting card of the Founder which sets the playground. A Good Pitch which showcases the product or the startup with right numbers and valuation makes a lot of impression. It should define the need of the founder to negotiate as to how much fund is required and what is the equity that the startup is agreeing to share with the investor.

Remember, it important to secure funds from investors to scale business, build robust technology and not to fund the expenses of the startup.

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