Photo: Entrepreneur Franchise 500
One of the most common mistakes I see with entrepreneurs is the process (or lack of) they use in valuing their business when it comes to raising capital.
In our enterprise, we have had the opportunity to analyze more than a few hundred businesses annually. There is some commonality to the errors that we see, but largely it revolves around the perceived value of the business as compared to the real value of the business as seen from the eyes of the investor.
In one phone call, I remember chatting with the principal of a tech company in the beacon-streaming sector. He proudly walked me through his business plan and asked if I had any questions?
As a matter of fact I did. I wondered where he derived his assessment of his company’s value? He had pegged it at $5 million. It was a very interesting number I recall suggesting, in fact, it is a very round number.
What happened next is pretty typical: he defended his price with no facts or science at all. Simply that he knew his company was worth that.
My next line of questioning was in regard to what his company had achieved. The answer was that he had a good idea. He had not made any sales, but like every company, he was about to.
In reality, his company was worth nothing or at least almost nothing. He had a good idea and he had spent other people’s money developing a good idea, but he had not proven it in the market.
The biggest mistake we see is overvaluing your company very early in your genesis. It means that the shareholders you may be fortunate enough to bring to the table have no room to grow their investment without substantial leaps in development of the company.
The problem is then compounded because the first shareholders are usually the worst offenders. They want to see growth in their value and so they arbitrarily increase the value of the company’s stock.
I get it, it is human nature, but it also spells the demise of the company’s ability to attract capital to operate and reach strategic milestones that add real value.
Back to the conversation. I pressed the entrepreneur on where the valuation came from and finally he suggested a well-respected friend told him his company was worth that much.
It was all I needed to hear. I indicated I was not interested on the basis that the valuation was so far off base. Of course, the entrepreneur defended his position and argued he would find the money and we said our good byes.
Imagine my surprise the next day when I received a call from the same gentleman. He thanked me for my input on the previous day and suggested that he had thought about his valuation and decided his company was today worth $2.5 million.
I explained again that $2.5 million was also a very round number and interestingly it was exactly half of yesterday’s value. Did he have a reason why?
Of course, it was as much a farcical number as the previous day’s and showed a serious lack of business intellect on behalf of the owner.
Sadly, this process repeats itself far too many times. The lesson might be to figure our what your business is truly worth today (with some consideration given to opportunity) not what it might be worth tomorrow.
That is tomorrow’s value.
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