A Practical Guide to Angel Investing (2nd Edition)

Angel Valuation Methods Expert Angels say they use multiple methods to determine a valuation range before they start any serious negotiations. The traditional valuation methods for big companies with stable cash flows are totally inappropriate (e.g., discounted cash flow, projections of future profits, asset value, book value). In contrast, Angel methods emphasize the value of the human capital, intellectual property, key reference accounts and solid strategic partners.

In all these methods, we are talking about the pre-money valuation of the company.

Revenue multiple method – If there are any revenues, and often there are not, you can at least set a minimum valuation as 2–3X revenue. This is probably the most highly referenced method, because it is so easy to calculate and so favourable to the investor. This method, however, assumes very low growth rates and gives no value to the quality of the management team. That is why this method often is used to determine the bottom of the valuation range. Make it worth my time and attention method – Some lead investors will say, “I need at least 10–20% of any company to get my attention.” At the other end, smaller investors may say they want at least 1–2% of a company. So some Angels will only get involved in the “sweet spot” where the overall syndicate is buying about a third of the company, which ensures that at least certain members of the syndicate will have a vested interest in corporate governance and follow-on investing. Standard value or market value method – Many Angels say that all interesting companies have essentially the same valuation. These Angels will cite $2.5–3.5 million as an example. Others will have portfolio targets with a pre-money valuation range of $500,000–4 million. The scorecard method (see next page) is often used to refine this standard value. Discount to terminal exit value (rate of return or venture capital method) – This valuation method was originally created by VCs and merchant bankers who were providing bridge funding for a known exit. Since Angels are usually investing in early- stage companies, their ability to predict the time and size of an exit usually makes this method unusable. However, in some cases, it may be appropriate. If, for example, we expect the investee to be acquired for $30 million, and the investor has an investment hurdle rate of 5X, we know the maximum allowable post-money valuation to be $6 million.

Post-money valuation = Exit value Minimum ROI

74 A Practical Guide to Angel Investing

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