Different Frames of Reference on Valuation
Valuation perspectives can vary from person to situation to company. Here are some key approaches to be familiar with.
Both entrepreneurs and investors can have different views on how to value a company. There are many ways to value a company that we won’t go into here. There are also ever changing trends in valuation based on market timing/dynamics. More fundamentally, there are different schools of thought on the basis of the valuation … none of these are necessarily right or wrong, but it does impact how you frame the valuation conversation. Depending on who you are speaking with, they may be approaching valuation from one of these different approaches.
Based on a big idea
In this model, the entrepreneur has an idea for something big. There is often no product or customers, but just an initial founding team with an idea to solve a problem. Since there are no financials to review or customers to gauge economics, the bet here is on the team and the market. If going down this path, focus to ensure your dream is communicated by selling the power/timing of the team, the size/potential/timing of the market, and the effective customer discovery that leads you to believe in the dream. Experienced entrepreneurs with past success often command higher valuations here. At this early stage, there are also debates over whether or not to use tools like convertible notes that punt valuations down the road.
Based on a bigger vision
In this model, the entrepreneur has traction in a small/niche market. There are numbers to analyze and customers to interview, but the belief is the current market is just a stepping stone for a bigger vision. If going down this path, a lot of the focus is to prove earlier customers in these adjacent markets and how your team/product easily fits these other customer segments as well. The valuation would go beyond just the current business model and into the future opportunity as well. Think an early Uber going beyond just the black car market.
Based on current reality
In this model, it is often focused on the current business operations and much more mathematical based on customers, revenue, growth, margin, retention, industry, etc. Assuming the numbers and references check out, there are standard multiples based on the above factors. If going down this path, it is much more about proving the value of what you are currently doing and why that is sustainable.
The reality is valuations are both art and science. Having a view into what story you are trying to tell as well as how the investor thinks about valuations can help you have much more productive conversations. At the end of the day, if you build a great business the valuations will follow.