The most important component of the investor plan is “valuation.” Valuation is defined by a company’s ability to generate cash flow in the future. It is more of an art than a science, particularly early in the life of a business, so valuation is often subject to great latitude and negotiation. This is particularly applicable to businesses that have yet to create any revenue or profits to speak of. The entrepreneur must recognize that the key to valuation is focusing on the future.
Here’s the trick, though.
The entrepreneur should always attempt to work on valuation with potential investors. The risk of “getting it wrong,” valuing the company too high or too low by proceeding unilaterally is too significant to overlook. A valuation that is too low could be costly for the company. A valuation that is too high can end potential investors’ interest on the spot. Rather than leading with a proposed valuation, the entrepreneur should collect information relevant to valuation and present that in a constructive manner.
The entrepreneur should begin the valuation process by finding out how much similar companies in the same niche and geographic area are worth. Information regarding sales of businesses in the entrepreneur’s industry are readily available on business web sites. Accountants and lawyers can also provide advice about market rates for comparable companies. They can further assist with the countless valuation methods used, ranging from multiplier methods to discounted cash flow methods to virtual CEO methods.
There are pros and cons to all of these, and an advisory board can assist the entrepreneur in determining which valuation method would be most applicable to the needs of the venture.