As a venture capitalist, people are always asking me, "How do you determi=
ne
the value of a business idea?" The real estate market provides an excelle=
nt
analogy. Anyone who has dealt with real estate appraisals knows that two =
key
elements are location and comparables - what similar houses in the
neighborhood are selling for.
In the case of a private company valuation, substitute industry sector fo=
r
location. For example, an Internet-related start-up would be the equivale=
nt
of a multimillion-dollar home in an exclusive community. A communications
start-up would be equivalent to a million-dollar home in an upper-middle
class area. An enterprise software start-up would be comparable to a
half-million dollar home in the nice middle-class part of town.
A house's condition also affects its salability. Is it ready for occupanc=
y
tomorrow? Or is it a fixer-upper that is going to take work to make it
habitable?
To determine a venture's salability, venture capitalists look at a number=
of
issues:
Does the company have a strong management team already in place or will t=
he
investors have to do the job themselves while they look for key managers?
Is the company's business model proven or untested?
Is the company entering an existing or new market? If existing, is that
market growing or shrinking? If new, does the market have the potential t=
o
be large?
How much technology risk is associated with the company's success or
failure?
What unique contribution will the venture capitalist provide in terms of
strategy, people and a network of possible partners?
A company with a fully formed business plan and a strong management team
would receive a higher valuation than a one in which investors would have=
to
put in a lot of time and effort. People invest in real estate with the
thought of selling for a profit. In the case of venture capitalists, they
look at what is called the "liquidity event" - the moment when the ventur=
e
capitalist realizes a return on his investment, either through an initial
public offering or the sale of the company. The IPO market, the
merger-and-acquisition environment and the market size for the company's
products all figure into determining the potential value of the liquidity
event. Each venture capitalist fund has its own requirements for valuatio=
n
driven by its investment strategy. Different funds will have different wa=
ys
of providing value, either through the amount of money invested or throug=
h
the time the firm's partners spend on each investment.
Every home seller believes his property is special and deserves to be ful=
ly
valued. Every entrepreneur feels the same way. But market forces are the
ultimate judge of value, whether you are engaging in a real estate
transaction or a venture deal.
Tushar J. Mehta
email: [email protected]
voicemail: (206) 405-2335