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Company Valuations When Raising Capital...

Mar 13 2017
There is a ton of information available on the internet about how to value a business enterprise (including some on this blog). There is even a lot of information regarding the valuation of a pre-revenue startup during rounds of funding. Unfortunately, most of that information is not particularly helpful for startups unless they are in a major center of startup finance (i.e. Silicon Valley, Boston or NY), have a good track record, and plan to be working with the established players.

If you are a startup company with high aspirations in Hometown, USA (like most of the South), then that deal making process, including valuation, will probably be very different.

First off, there are not a ton of institutional players interested in pre-revenue deals, so angels play a larger role. Angels, however, are just people and people don't tend to write a binding prospectus with projections and investment philosophies, etc. when investing their own money. Instead they invest based on a much fuzzier standard that depends on a lot of qualitative factors, including things such as mood.

In many of the deals I know well, the focus tended to be on shorter term goals and getting the investment paid back while still providing an opportunity for the company to reach its goals. That often results in terms that are based a lot more on the stage of the business (pre-prototype, pre-revenue, pre-profitability, etc.) and will incorporate debt or debt-like features.

For example, local angels tend to look at deals with a post-money valuation of $1mm or so that includes an investment of a few hundred thousand dollars with a 1x participating liquidation preference. But those terms are really driven by the type of typical deal:

1. pre-revenue (or little revenue) and post-prototype,
2. reasonable cap-ex for launch,
3. large potential market,
4. clear near term profitability milestones,
5. 1-2 years to initial milestones,

and the desire to provide necessary funding, create a significant potential upside for the investors while maintaining functional control for the founder(s).

However, individual (as opposed to group) angel deals can have some really interesting (and convoluted) terms if the investor is being creative. Sometimes that can help a deal and sometimes they are just clunky, but if it gets the deal done...

Either way, if you are working on raising capital in "Hometown USA", have good counsel and be prepared to openly discuss the deal and be creative because the process probably won't be as cut and dried as the internet may lead you to believe.
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Joshua Watkins

Mr. Watkins is the Managing Member at Watkins Law Firm, LLC.  His legal practice has primarily focused on working with private companies as general counsel. As general counsel his duties typically include an array of tasks such as: in-house day-to-day activities, advising the company’s board of directors on their oversight responsibilities, planning and preparing complex corporate transactions, commercial litigation, tax planning, oversight of the corporation’s compliance with federal and state regulations, legal budget management, and specialized outsourcing of legal matters to other counsel when appropriate.

When counsel to emerging start-up companies, Josh often brings critical expertise in the many types of capital formation activities, including entity and structure choices, fundraising processes, and securities compliance.

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