Owners of seed- and growth-stage technology companies often ask me, “What is our company worth?” It’s an important question to ask, certainly. But before going through the process of determining value, I think it’s important for companies at these particular stages to understand when they need a valuation. And it’s likely when one of the following scenarios occur:
When you have equity-capital formation
When you have stock-based compensation
During an exit or liquidity event negotiation
Each of these scenarios brings with it distinct, unique characteristics that require careful evaluation.
Equity Capital Formation
Because seed- and growth-stage companies lack the operating history to leverage more scientific valuation models, negotiations between the entrepreneur and the potential investors drive the starting point for value. These parties base their pre-money valuations on qualitative factors, such as the innovative and disruptive nature of the technology, the team, competing companies, fundraising trends in the local and national market, growth trajectories and potential exit markets. During these negotiations the entrepreneur is motivated to achieve the highest valuation possible, and for the investor, the lowest.
Seed- and growth-stage companies need to conserve as much cash as possible. Therefore, the compensation of key employees and advisors is often supplemented by stock options. The entrepreneur is motivated to grant stock awards to their employees at the lowest possible exercise price that will meet the fair market value requirements of the IRS. A low price provides the employee or advisor with a perceived benefit when the value of the stock increases above the exercise price of the option. When the option is exercised — the employee or advisor wins!
Exit or Liquidity Event
The ultimate goal of nearly all seed- and growth-stage companies is to create significant value that can be realized upon sale to a strategic or financial buyer, or result in a liquidity event such as an initial public offering. The entrepreneur and their investors are motivated to achieve the highest possible valuation for the company as a reward for the risk and hard work invested over the company’s life cycle. Exit values may increase and decrease over the roller coaster life of the company as different milestones are achieved or missed. Every entrepreneur and investor wrestles with the determination of identifying the highest value inflection point for the company.
Once the scenarios and goals for your tech company have been outlined, then is the time to look at the art of valuing the company. And that is a whole other story. Read more about the process in "What is Your Tech Company Worth?"
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.