Advice from David Pattison - Investment expert & Best selling author

When you are looking for investment or looking to sell your business, understanding how to value your business is fundamental to the success of the raise or the sale.

The valuing of businesses is no different from any other form of commerce, there is a mix of science and art in getting to an agreed price.

In its most simplistic form, the valuation process really splits into two: 

  • valuation with no clear data and analytics  

  • valuation with proven data and analytics

These types of valuation then typically fall into two phases of the business, the first being pre-revenue or at early revenue stages and the second being when there is proof of concept and some established revenue patterns passing through the business.

How do you value these two phases?

Early stage with no clear data and analytics

This is usually when the business is in start-up or early development stage. The idea is that development and early funding is required to get to proof of concept or to the point of revenue generation or early revenue coming in.

At this stage, it is the hardest to justify a valuation because there is so little to go on. Having said that most investors at this stage don’t look too hard at valuation and are much more interested in you, your idea, the tax breaks they can get and the millions your business could make them. 

It sounds a bit flippant but in almost all cases these are the drivers of investors. At this stage, almost all the investors are Angel Investors or High Net Worth individuals and most likely to be people you know or people you have been introduced to by people you know. 

What I usually advise young businesses to do at this stage is work out how much money is required, link that to how much equity they are prepared to dilute their holding by, and then see if that valuation works in the market. It usually comes out on the high side and often the valuation needs to drop but it gives a useful starting point.

In this situation, it is almost all art and little science. At later stages, it is much more about science with a little art mixed in. 

Later stage with clear data and analytics

When your company is further developed there are a lot more data points that can be used to help set a valuation. Here are some of the numbers that are typically used to set a valuation:

  • A multiple of profit. These are usually Earnings before Interest and Taxation (EBIT) or Earnings before Interest Taxation Depreciation and Amortisation (EBITDA)

  • A multiple of net revenue (i.e. your annual income)

  • If you are a subscription business, then a multiple of Monthly Recurring Revenue (MRR) or Annual Recurring Revenue (ARR) can be used.

There will be many variations on these and there are also periods where certain valuation vehicles are ‘in fashion’. At the moment MRR and ARR are very fashionable if you have a business that attracts recurring revenue.

There is also market information that can be used:

  • Looking at deals that have been done in the sector. There is very often a lot of public data around deals done in the same sector as you

  • Look at the publicly listed markets to see what multiples are being attained by the companies in the same/similar sectors. If you are a private business then you will probably be expected to drop your valuation by around 25% as there is almost always a discount built in for private businesses where selling shareholding at any time is more difficult.

Then there are some variables to consider:

  • Are you fast growing with that growth likely to continue? If so then expect a higher multiple

  • Is the management looking to exit? That might result in a lower valuation

  • How many potential suitors are there? There is nothing like competitive tension to drive up a valuation.

  • Are you in a high-value or ‘sexy’ sector? We have seen the tech sector explode over the last ten years and then implode recently. Getting your timing right is often a key driver

None of these lists are exhaustive but they do demonstrate that there are many moving parts and many levers to pull when it comes to valuation setting. As I said at the beginning it is almost always a mix of science and art. 

Having said that, all the above is only really used to solve one equation; what price is an investor/purchaser willing to pay and what price is a fundraiser/seller prepared to accept. That is the real driver of all valuations with everything else being used to justify the numbers.

David Pattison is a start-up funding expert, business chair and mentor, and author of The Money Train: 10 Things Young Businesses Need to Know About Investors. The book won the best Startup / Scaleup book at the Business Book Awards 2022.