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Diary of an entrepreneur raising capital: The dark art of valuations


Oodles.com founder Steve Sherlock has set himself the goal of raising a multimillion dollar Series A funding round by the end of January 2010. He is documenting his trials and tribulations and seeking feedback from readers on AnthillOnline.com. This is the fifth post in his series.

Week 5: The dark art of valuations

This week I’ve been attempting to work out the value of our company, which means I’ve been taking the business world’s equivalent of a Dark Arts class at Hogwarts.

Coming up with a pre-investment (or pre-money) valuation is necessary in order to work out how much equity a potential investor ends up with. And coming up with a valuation that is agreeable to all stakeholders is critical, unless you want to go back to prospects with a revised price after a bruising internal dispute.

The theory is as follows: if the pre-money valuation of a company is $1,000 and an investor puts in $500 to buy new shares, then the post-money valuation is $1,500 and the investor holds 33.3 percent of the total shares (diluting the existing shareholders stake by the same amount).

In our first round of investment some three years ago (when I had my L Plates on) I thought that if the company was worth $1000 then an investor injecting $500 would end up with 50 percent of the company. That would, of course, only be the case if no new shares were issued and the $500 went straight into my pocket. Doh!

I decided to calculate a rough valuation by basically adding up what has been invested and re-invested into the company so far. My next step was to find a way of supporting the figure.

My first thought was to break down the different segments of the company (product, brand and IP, traction and potential) and apportion a value to each. I was aware, however, that this was a pretty subjective approach.

I also realised that I’d not taken into account money reinvested from revenues. Was this an acceptable practice?

Another option was to start again and use the common approach of devising a value by using a multiple of current profit — or in our case revenue. That seems a fairly straightforward approach until you have to also add in future revenue/profit potential for a highly scalable business like ours.

Finally, if one is talking to both potential investors and buyers, you need to be mindful that the valuation will likely need to be different for each.

At this point I’d have been happy to add two drops of unicorn’s blood, a twig of mandrake and a dash of love potion in the hope a valuation would magically appear before my eyes.

After all my agonising over the correct formula to apply, it was pointed out to me that ultimately the value I put on the company is irrelevant because all that matters is what the market is willing to pay.

With that in mind, I’m now planning to test out the valuation I’ve arrived at on as many real ‘live’ potential investors as possible.

In the meantime, I’d be interested to hear what other formulas you have used or heard of.

Steve Sherlock is co-founder of Oodles.com, one of Australia’s leading online car rental aggregators.