What is Your Tech Company Worth?– December 08, 2016 by Jeff Kovacs

The number one question entrepreneurs of seed- and growth-stage technology companies and their investors ask is: What is my company worth? The answer depends on many factors; however, there is one universal truth. The process is primarily an art that uses only a little bit of science. That’s because scientific valuation methods just aren’t very helpful in arriving at a value for companies at these stages.
 
The art of valuation will vary depending on whether you are dealing with equity-capital formation, stock-based compensation, or an exit- or liquidity-event negotiation.

Equity-Capital Formation

Many approaches have been developed over the years to capture enterprise value for seed- and growth-stage companies, but applying multiple approaches often makes sense to attempt to converge on a range of values. Further, it’s critically important to understand that valuation is not the sole driver of an equity raise. All of the terms and provisions must be carefully evaluated and negotiated. Accepting terms without modeling the outcomes can have the unintended consequence of eroding value for entrepreneurs and investors when a company exits. Entrepreneurs should familiarize themselves with the Berkus, Venture Capital and Scorecard methods. Each of these methods is inherently simple to adopt but almost always incorporates significant judgments and assumptions about:

  • Stage of commercialization

  • Level of technology risk

  • Management team quality

  • Expected outcomes

  • Rates of return

Much has been debated about the use of forecasted revenue, profits and discounts to arrive at values at this stage, yet for seed- and growth-stage companies, revenues and profits are almost impossible to determine.

Stock-Based Compensation

Stock-based compensation must be valued for both IRS and GAAP purposes. Because this is primarily a compliance exercise, companies often engage an independent valuation specialist to conduct a 409(A) valuation to support the value of the common stock underlying the award. In practice, private technology companies usually leverage this report to determine the value of the underlying common stock for GAAP. These valuations employ an option-pricing-model or a market approach, using benchmark company comparables to arrive at an appropriate exercise price. These models have the benefit of drawing upon some market information or recent transaction history to arrive at a valuation, yet still involve the use of significant assumptions to arrive at an expected value.

Exit or Liquidity Event

When a company is ready to exit to a strategic or financial buyer, there is often operating revenue or cash-flow history as the basis for more scientific valuation methods. While more sophisticated discounted cash-flow and market-valuation techniques may be available, entrepreneurs tend to arrive at an expectation of value using some multiple of revenue or cash flow based on published evidence from similar transactions, evidence from investment bankers and others involved in the deal process or their own data-intelligence gathering.
 
The artful valuation of a seed- and growth-stage company begins as a blank canvas that comes to life as the story of the company unfolds. The judgments, assumptions and market intelligence become the brushstrokes that, when blended together, help the entrepreneur bring focus, clarity and color to the very gray world of valuation.

Read our related our article on when to think about valuing your tech company.
 
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.