Grim Fairy Tales – Part II

You learn something new every day (they say) and I certainly find this to be the case. Whilst I am often asked how to raise money or attract investors, I find it is easier to demonstrate how not to do it, based on my own experiences (and those of people I know).

Last week for instance I told the tale of the CEO and CTO who got into an argument during an investment pitch (see here) – and the lesson was how important the management team is to an investment.

So if management is a key part of every investor’s decision making, so is valuation, the topic of this week’s Grim Fairy Tale. For obvious reasons all names are changed, and in some cases the details are “blurred” to protect the feelings & identities of the not so innocent players.

A few years ago I was sitting at my desk with a magnificent view of Liverpool Street Station, when the phone rang and a voice on the other end of the line said “Do you invest in technology companies?”.

“Yes we do”, I said and asked for details.

The man on the other end introduced himself as Philip, and gave his company name (there was no clue in the name as what the company did) and proceeded to tell me that he had invented a new kind of car door lock. It had not been put into production, but had been very favourably reviewed by Ford, Vauxhall, Citroen and Mercedes to name but a few.

How it worked was a carefully guarded secret, but the early prototypes had worked well and the product was ready for the big time.

At this point I asked how much he was looking to raise (I kept a check list in front of me at all times, but the amount was a question I could remember. The answer came back “£1m pounds”.

“How much of the company do I get for £1m?” I asked.

“One percent”.

Now it is a common point of failure in an investment discussion when we get to valuation, but this example sticks in my memory. To value a pre-revenue company, with a prototype product at £100m takes some confidence (and then some) but it is so wholly unrealistic that the conversation simply cannot continue, at least without further questioning.

Valuations have dropped since the frenetic days of 2006 and early 2007. Pre-revenue companies are unlikely to command valuations of much more than 500k to £1m unless there are exceptional circumstances or clear and immediate revenues. Basing valuation on future forecasts, without any track record, is no longer credible. Yet every day we all see it happen.

No-one wants to undervalue their business, and investors understand this. So have a realistic valuation that you can credibly support before you ever meet an investor. And credible support does not include discount cash flows based on sales that are many years away!

Next time: USP

 

Permanent link to this article: http://www.concap.cc/2012/05/grim-fairy-tales-part-ii/

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  1. […] far I’ve covered Management in Part I, Valuation in Part II and USP/Market in Part III. This time we’ll take a look at […]

  2. […] Valuation […]

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