Bangalore has many angel investors these days. In the last six months, I have come across several persons and groups who have expressed interest in funding start ups in the city. While this is good news, an entrepreneur needs to tread carefully before accepting money. In addition to the quantity of money, the quality of investment may also be important. Entrepreneurs need to understand what they need. Sometimes it may be more than money; they may need customer contacts and advisory inputs.

Entrepreneurs also need to view this from the angle of the angel investor. Why would the angel be interested in putting some money in the start up? Are they looking for great financial returns? Do they understand the risks involved? Will they get involved in the day to day operational affairs or will they just look at the overall business model and strategy?

Entrepreneurs need to be clear about what they are willing to give up in their business. Are they willing to give up equity and if yes, how much? Much of this is also linked to valuation of the start up. And therein lies the problem! In the case of a start up, the value is driven by the perception of the future. In an early stage venture, perceptions of the future can be varied. Some more thoughts on valuation:

Valuation is based on:
– intangibles and
– tangibles
In the case of a start up, the tangible (land, building, cash on hand etc.) is very limited and much of the value is in the intangible, driven by the promoters background and networks, business idea, potential market opportunity and ability of the new firm to capture this opportunity.

Valuation can be computed in multiple ways, the popular methods:
– multiples of revenue; profit etc.
– multiples of key drivers, e.g. user base
– cash flow based

Here one would like to look at comparable transactions in the market, to bench mark the valuation of the company. In most cases, when one wants to get data on the comparables, there is a practical problem. Much of this data and related information is not available and is out of public domain. Here is where one should leverage on one’s networks to get some information about current transactions.

Different persons can value the same business differently because they may
– use different methods of valuation
– use variations in the methods
– have different inputs in the methods

Thus, valuation perceptions can vary, and we do have situations where there are divergent views on valuation. Deals can sometimes be structured in such a way that the differences in valuation perception are factored, e.g. linking valuation to performance in the future. This is of course assuming that the promoters and investors are keen to work together and strike a deal. Negotiations play a key role in this process. It is good to identify the strong points and the risks in the business as these will impact one’s bargaining power.

The two sides need to remember that they are not planning to be on two sides of the table; they will become collaborative partners in the start up if the investment is made. Valuation is the start of this process, not the conclusion.

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