The higher the value of your business, the less stock you have to sell to get your business funding.

But, how do you determine the value of your business when it doesn’t have a history of cash flow, a book of customers or any other criteria that are typically used to establish value?

Valuing an emerging business for purposes of venture capital financing or angel investors is based on two factors:

1.) The rate of return required to compensate for the risk of investing in the enterprise; and

2.) The expected enterprise value at the time of the “exit event.”

The first factor depends on the general investment climate and the fact that investing in a start-up is extremely risky.

Today, professional investors would expect at least 10X return on investment over a 5 year period. This is much higher than it was a few years ago because the risks of investing have increased.

As a result, for each $1.00 of investment, you’ll be expected to return $10.00 to the investor in the fifth year. The money to pay the investor is generated by an exit event.

There are three types of exit events: liquidation, initial public offering (i.e. “going public”), and sale of the enterprise.

Liquidation is usually a bad outcome. The company’s assets are sold, creditors paid and the remainder is distributed to the shareholders. Goodwill – the portion of value that makes the company worth more than the sum of its tangible assets – is usually lost.

Since 2002 going public hasn’t been a viable exit strategy for most growing companies either. Because of changes to federal laws, the process has become too burdensome for most emerging enterprises. And, given the economic situation in the United States today, there is little appetite for relatively small public companies.

Therefore, the only exit event available today is the sale of the enterprise to a larger enterprise.

Sometimes entrepreneurs erroneously believe that they can buy out their investors at some point in the future. However, because, as you’ll see below, the enterprise value is based on cash flow and that cash flow would be the way to pay an investor, it’s almost never feasible to buy out an investor.

For this reason, you should view all potential investors as true financial partners – you’re getting married economically to them.

This also means that, by bringing on financial partners, you’re agreeing to sell the enterprise in about five years.

Enterprise value for a sale exit event is generally based on a multiple of the EBITDA (earnings before interest, taxes, depreciation and amortization).

EBITDA is essentially your business’ cash flow. And the multiple is similar to a P/E (price to earnings) ratio in the public market, although a multiple is usually much lower than P/E for various reasons.

So there are two values that must be “determined” to arrive at enterprise value at the time of the exit: EBITDA in the fifth year and the appropriate multiple to be used.

This is where the emerging business valuation game is played in the investment capital world.

Your EBITDA estimate for year 5 is based on the financial projections (guesses) and assumptions in your business plan. There are always points of contention that will make the investor’s opinion of EBITDA in the exit year different from your opinion. But, your assumptions must be reasonable and must be specifically stated so your projection can be properly evaluated and defended.

Likewise with multiples. Multiples are a reflection of the risk of the enterprise going forward: a higher multiple means less risk. Multiples vary quite a bit by industry. You can increase the multiple (and the value of your company) by eliminating risk, such as, for example, by having paying customers or proving that your technology is commercially viable.

Putting it all together, let’s say, for example, you’re looking to raise $1MM. Your business plan financial projections show an anticipated EBITDA in year five of $5MM. Based on your research you believe that private companies in your industry area typically are valued using a multiple of 6. And you know that your investor will typically look to received $10MM in year 5 through the exit.

Based on your EBITDA and multiple estimates, the enterprise value in the fifth year should be $30MM. This means that, in order to receive $10MM of the $30MM sale price, your investor would have to hold 1/3 of the equity interests to achieve the desired return.

Therefore, you would expect to sell 33% of the common equity interest of the company for $1MM in the current year and the post-money valuation is $3MM.

Of course, this isn’t a science and opinions as to EBITDA and multiples will vary. To be taken seriously, you have to make an informed and reasoned valuation case.

Furthermore, professional investors will also include downside protection so that, if things don’t work out, they’re first in line to recoup their investment. As a result, they’ll purchase a preferred stock that provides these and other protections over and above the common stockholders.

So what happens if you don’t have sufficient cash flow to justify an investment? This just means that your business probably isn’t a candidate for venture funding or that you have to consider a different business model.

An accurate basis for valuing your emerging company will ensure you sell stock at a fair market price and don’t give up more equity than necessary to raise capital and it will tell you if your company is qualified to secured venture funding.

The above is provided solely as general information. It is NOT provided as legal, financial or other professional advice and should NOT be construed as such. DO NOT rely on the information in any way. You should NOT take any action or refrain from taking any action based on the above information. Rather, you should consult an appropriately licensed business lawyer for your particular situation.

Author: Edward Alexander
Article Source: EzineArticles.com
Provided by: Digital Camera News

All the above begs for this question: How can any company, be it public or private, set itself free from the above financial limitations, and raise the capital that will allow it to take the next step in its business life? The less than optimal choices to raise capital, and in particular for start-ups, is not new to company founders, corporate directors, and other company officers; all have been exposed — to some degree or other — to the capital-raising paradox. The steps they took to overcome its limitations to company growth and expansion is the subject of this study. Your new business enterprise can overcome the above capitalization catch-22 and achieve great results! Here is a preliminary guide to help your company raise capital:

(a) Join business incubator focus groups, discussion groups, advisor boards, community business organizations, business development groups, business roundtables, professional business forums, local fraternal business chapters, and business blogs.

Seek the advice and tutoring of the older, more experienced CEO or CFO. This is such a golden opportunity on account that these older executives offer a lifetime of practical experience to share with younger upstarts; your company will benefit greatly from their generous business know-how and experience.

In addition, although the retired executives are no longer actively running their own companies, they enjoy assisting younger, up and struggling corporate officers because — in a vicarious way — they get to relive the romanticism of their younger “glory days,” and that is one of the reasons they are glad to help, and keep abreast of the action.

(b) Get your business plan ready! You should produce a well written and insightful business plan, since it is one of the most essential tools employed to raise capital. Few things are more essential for your company’s capitalization search than offering your capital funding sources a thoroughly researched and meaningful business plan. The presentation should get across your strategic corporate planning, the avenues your company intends to seek to grow and expand, and your general business experience.

However, the most vital part of any business plan is to appraise the proposed target — the investment advisor that may consider it — how your corporation will use the capital. What are the development steps your business is going to put in place to use the new capital? Remember to review and revise your company’s business plan as the need arises; it should reflect any new business opportunities, and pertinent information about the market outlook of your company.

I know I’ve already mentioned this, but it bears to be repeated: It should come as no surprise that a competent and resourcefully rendered business plan will greatly improve your company’s chances of raising capital.

(c) Scrutinize the funding sources you propose to contact. The proposed targets of your action to get corporate financing, consisting of: investment banks, venture capitalist (VC), angel investors, securities broker/dealers, investment advisor firms (IA), sophisticated investors, and accredited investors, should all be given a careful appraisal. The gist of the deal is to assess if they have specialized in your particular business. Analyze their resent funding activity to see if they have provided financial resources to comparable businesses in your market segment. There is a very strong chance they would be open to the idea of helping your business enterprise raise capital, too.

When invited to do a presentation, keep it short, sweet, and to the point. A four page outline of your business plan is more than enough. By all means, avoid the temptation of name dropping and only provide a short list of the principals and experts that are really engaged in your business enterprise. Remember: quality is much better than quantity!

(d) Additional avenues to explore, while your enterprise is busy raising capital, is professional “proof of concept” regarding your corporate structure, manufacturing, and feasibility studies. High technology companies blazing a new path, as an example, could be bringing to market items and innovations that are ahead of the curve, light years away from presently available systems.

Since nobody has ever seen — or even thought of the idea — there could be a degree of hesitation encountered from the directors at investment banks, corporate capital sourcing and broker/dealers. Professional and technical validation of your company and products can greatly help to provide answers to groups and individual investors that are the most important: your proposed sources of capital formation!

(e) Notwithstanding that this is mentioned last, it will serve to give life and action to everything we’ve discussed so far. The magic quality that makes raising capital, and corporate growth and expansion possible, is this: do not get frustrated and walk away! When your financial explorations lead but to a dead end, don’t dwell upon it and move on to the next one, since it could lead to this: the open door that has a receptive and open mind, and will be very actively involved in helping your company to raise capital.

(f) Every capital funding proposal should receive thought-provoking consideration prior to going on to the next deal. If you pursue this broad — yet specific — guide, your startup business will grow and conquer new markets through the art of raising capital.

Author: Frank Roberson
Article Source: EzineArticles.com
Provided by: Hybrid and Electric Cars