In the era of tech unicorns, every startup dreams of getting its hands on some of that widely available VC cash. Even as investors become more cautious, new companies are still attracting millions of dollars in funding. Why wouldn’t founders want to take as much as they can?
In many cases, the more money you take from investors, the less you’ll take home on a percentage basis in the end. What you’re banking on is that the investment will be used to significantly accelerate the value of your business and grow your returns on a capital basis. Announcing a successful Series A round might sound glamorous, but many business owners end up disappointed in their long-term gains when working with investors.
If you do pursue investments, don’t just rush into the first pitch meetings you can set up. Think carefully about the request. The amount should include everything your business needs to grow. Investors will be wary if the ask is too small to be effective or too large to be justified by the planned use of proceeds.
Once you’ve settled on an appropriate sum, it’s time to think about what kind of money you’re going to seek. Educate yourself on the different funding sources so you can choose one that suits your business. This is also the time to think about your end game.
That may seem counterintuitive. After all, you’re raising money so you can expand. Nevertheless, it’s an important question. Every founder exits his or her business at some point, whether that’s through a sale, a liquidation, going public, or handing the reigns to a successor. The exit plan, in large part, determines the value growth strategy, which in turn impacts the go-to-market strategy — which determines key aspects of the business model and plan, which then affects the type and terms of funding you seek.
Know Your Valuation
Funding doesn’t happen in a vacuum. Any investment plan must be integrated into your market and exit strategies. If these components aren’t aligned, you’ll lose money or receive an unfavorable valuation down the road. To ensure this doesn’t happen, you need to know what’s actually creating value in your business.
When Zero Limits Ventures conducts client assessments, we publish an independently determined valuation opinion. It gathers historical data from similar companies, applies discounted cash flow methodologies, and runs competitive market analyses to determine a business’s worth.
Many business owners stop there and make the mistake that bases the market value of the business at that resulting valuation. If the estimated valuation is $13 million, that’s where they set their expectations. We don’t do that. Instead, we use that numeric representation as our base point and consider all the ways a given business can be justifiably value-enhanced. We begin that process by evaluating all the potential buyers we can identify, seeking to understand the aspects of a given business that interest them most and why.
If a buyer is eyeing your customer base, how much will the purchase impact his or her revenues and, more importantly, his or her valuation? The company may well be worth more than $13 million when you account for potential revenue and earnings-based valuation increases. Perhaps a second buyer wants your intellectual property and is willing to pay top dollar — even more than the one who wants your customer base.
The same basic formula exists: The amount they’ll pay has more to do with the value potential of the business for their specific needs than the numeric calculation of value. Having a realistic sense of both your baseline value and the valuation gains available to you gives you more leverage when meeting with investors. You’ll open yourself up to more interesting and lucrative deals and investment opportunities by having a solid value growth strategy.
Exit Strategy First, Funding Second
Again, planning for your exit before you seek funding may seem counterintuitive. But doing so now will tell you which investors to target and where to direct their money. Investors often bring more than cash to the table. They also provide mentorship and access to their extensive networks. You want to partner with people who can steer your business with both their capital and their clout.
Here’s how to position yourself to find the right partners:
1. Analyze your constraints.
Before meeting with any investors or potential buyers, conduct a thorough analysis of possible constraints to valuation. There are many different factors that can impact that number, and they’re not always apparent to business owners.
For example, one client had failed to document important information — such as its standard operating procedures, company structure, competitive analyses, sales performance, and marketing initiatives. While the business was performing acceptably enough to attract investors, it’s very difficult to determine a business’s fair market value if you don’t know how it’s structured. Documenting these components adds significant value without regard to revenue and earnings.
2. Understand your potential buyers.
Study the buying classes and networks of organizations that would be interested in buying your company. Find businesses that are comparable to yours in terms of structure, size, and age, and assess how you stack up. This will give you a sense of how much outsiders might value your company, but don’t use that as a hard-and-fast metric.
Prospective buyers will have different prices in mind because they want to purchase your business for different reasons. The more potential value your business represents to the buyer, the higher the price he or she will be willing to pay.
3. Create a plan for capturing greater value.
Once you know what your buyers value, you can package the company to make it more attractive to a particular buyer. You might have thought your marquee product was the selling point, but in reality, it could be the proprietary software you built or the customer following you’ve amassed that’s driving the price for a given buyer.
Devise a strategy for implementing the changes and enhancements necessary to align your business with the interests of the highest-paying buyer. Let’s assume you’re targeting buyers who are interested in your customers. One is willing to pay six times your earnings for access to your audience. You’d want to become highly proficient at converting and retaining customers so you can maximize your returns in that transaction.
On the other hand, perhaps you’re more interested in a buyer who’s willing to pay eight times your earnings for your intellectual property or trade secrets. You may invest less in customer acquisition and more in your IP and branding at that point.
There is a caveat: If your business is set up in such a way that it’s less risky and more cost-effective to acquire and retain customers than it is to develop new IP, you may want to funnel your resources into maximizing returns in the first transaction, even though it’s less lucrative on the face of it. Above all, invest your money in the areas that will provide you with the highest returns when the time to exit comes.
Everything in business is connected. From the day you launch your company to the moment you sign it over to someone else, each decision you make influences the organization’s trajectory. Funding strategies are complex, and you must consider every angle before committing to an investor. Above all, you need to know your value. If you don’t assert your company’s true worth, no one else is going to do it for you.
If you’re ready to know exactly how to maximize the value of your business with a Valuation Growth/Strategic Exit Plan, complete this form to schedule a one-hour consultation with Steve.