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Wyoming Business Tips for July 24-30

July 15, 2016

A weekly look at Wyoming business questions from the Wyoming Small Business Development Center (WSBDC), part of WyomingEntrepreneur.Biz, a collection of business assistance programs at the University of Wyoming.

By Lisa daCosta, WSBDC Teton County business adviser

“My startup is not generating sales yet, but I want to give key people equity. How do I value my company stock when I don’t have revenue or earnings?”  Jake, Sheridan

Valuing a private company is similar to valuing a publicly traded one.

The method is based on evaluating how your company compares with peer companies in the same business for growth prospects, profitability and valuation, and the market forces in that industry -- how strong is investor demand for that product or service right now.

For companies that are so new that they are not even generating sales yet and may be losing money, a potential investor can use the First Chicago Method, which was developed by a Chicago-based venture investment group. That method uses three- to five-year business forecasts, cast through the lens of a best, worst and base case sets of assumptions, and applies a multiple on those forecasts to determine a terminal valuation.

That company valuation is then discounted back to a present value, using the investor expected return, which could be in the range of 10-30 times the original investment value. Each scenario is given a probability percentage, applied to the present value, to arrive at a blended valuation today.

Dave Berkus, a well-known angel and venture investor, has described an alternative method to value a “pre-revenue” business. His model begins with the premise that the target company can achieve $20 million in sales within five years, given its particular market opportunity and how the company is addressing it.

He then assigns up to a half million dollars in value for each of five critical operational elements, including the soundness of the business idea, existence of a prototype, a quality management team, strategic relationships and product rollout or sales plan.

Once a valuation has been determined, a business owner must decide if funds needed require giving up too much of the company ownership. Even when the business owner finds a willing investor, if the percent of the company to be sold or distributed today is large, and future funding rounds will still be necessary, there is the potential that the founder could ultimately own so little of the company, he or she will lose interest and motivation to grow it.

Using equity to fund the business or hire key people requires the careful balance of investing in the future success of the business and minimizing dilution of the founder’s percentage in the company.

A blog version of this article and an opportunity to post comments are available at www.wyen.biz/blog1/.

The WSBDC is a partnership of the U.S. Small Business Administration, the Wyoming Business Council and the University of Wyoming. To ask a question, call 1-800-348-5194, email wsbdc@uwyo.edu, or write 1000 E. University Ave., Dept. 3922, Laramie, WY, 82071-3922.


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