How to value a pre-revenue company is always a difficult question, but there are some tools and general principles to help guide founders when preparing offerings, and investors when deciding on whether to accept an offering.
More risk, more reward
In any open market what something is worth, is ultimately equivalent to whatever someone else is willing to pay, so the question really is, how do we determine what an investor is willing to pay for an investment.
Offerings are done in a series of ‘rounds’ designed to bring the company from one stage of its development to its next stage of development. Each round is designed to work in tandem with any other grants or lending received in order to progress the company to its next significant stage of development.
The more things have been developed, the more risk has been eliminated because there is less uncertainty.
For example, having a proven prototype, i.e. the product works or the Code has been written, the platform has been created and successfully piloted, there are already users or customers in the beta test phase, and a brand has already got some traction and attention.
As the rounds progress, investors will be willing to pay more dollars, for a less significant share of equity since the company is ‘worth more’.
Factors in determining risk
The experience level of the founding team including prior successes and failures is a big in factor in whether investors will be convinced to invest in your company, as well as how much of a return they will be looking for.
How much work has already been done, and how many obstacles have been eliminated are also a big factor.
Time commitment
What is the expected turn around time for the company to get to the point where the investors shares become liquid again?
The length of time it takes the company to generate positive cash flow will also greatly affect the annual return on investment.
Private equity investors are usually looking for a relatively high annual return on investment for a private share offering. There is no ‘rule’ but think double digits.
Potential earnings
Having a project development plan is key to determining a share offering. Having accurate cost estimates for the project, and accurate sales forecasts, will help you determine the ‘nuts and bolts’ of your share offering.
Future-oriented financial information including income statement and cash flow projections are often contained within the offering memorandum of the shares.
Of utmost concern in these is the potential for profit of the company, turn-around time, and ultimately the return on investment for the investor.