Winning Angels: The 7 Fundamentals of Early Stage Investing Book Reflection Week 4

The Valuation section of early stage investing is interesting to me because it’s not just about the numbers. It’s about the price as it relates to potential financial return, the use of your time, the opportunity to give back, contributing to a good cause, or just having some fun.

My takeaway from this section is the 12 Methods that make up the five fundamental approaches to Valuing in early-stage investing.

Quick & Easy approach is comprised of 5 methods;

  • $5M Limit is a simple method that says never invest in a start-up deal valued over $5m
  • Berkus Method is based on a formula for the tangible aspects of the opportunity and identifies a clear relationship between price and the aspects of the opportunity.
  • Rule of Thirds is a simple valuation based on a split of 1/3 to the founders, 1/3 to the capital providers, 1/3 to the management.
  • $2m – $5m Angel Standard seems to identify a sweet-spot, if the entrepreneur is asking for less than $2m then the deal is not preferred, and if they are asking more than $5m then it may be a better fit for a Venture Capitalist.
  • $2m – $10m Internet Standard is based on the potential for internet/high tech start-ups to grow very quickly.

Academic/Investment Banker approach is comprised of two methods;

  • Multiplier Method uses a projected number from the business plan, times an industry standard, for valuing an opportunity. The trick is using the correct industry standard number to accurately predict the return on investment.
  • Discounted Cash Flow method is a calculation that identifies a potential value of a company in the future, then discounts the value each year by a percentage between the future date and now.

Professional Venture Capitalist approach is solely a venture capital method that builds on the multiplier and discounted cash flow methods to determine how much of a company you should own to get the desired return on investment.

Compensated Advisor approach has two methods;

  • Virtual CEO Method includes providing significant support to a start-up in exchange for a percentage of the equity, and is a method for pricing contribution versus the company itself.
  • Start-Up Advisor Method is a situation where the angel agrees to provide some support to the start-up in exchange for some modest equity, with the intention of investing if the deal comes together.

Value Later approach has two methods;

  • Pre-VC Method is where an angel invests cash into a start-up without any shares trading hands and with no price set for future transactions. The initial investment often takes the form of a loan, payable in 12 or more months.
  • O.H. Method is primarily for controlling angel investors who provide the majority of the investment and guarantees the entrepreneur a 15% share of the company after the final round of capital.

For me, the simple and easy methods would make the most sense for a new angel, such as the $2m-$5m angel standard. There is a very good thought process that says multiple methods can be used by savvy investors to maximize their valuation efforts and take into account more complex variables. Applying multiple valuations can result in a range of value options that the angel can dissect and improve their odds for success.

David Amis and Howard H. Stevenson. Winning Angels: The Seven Fundamentals of Early-Stage Investing. Financial Times Prentice Hall, 2001.

1 thought on “Winning Angels: The 7 Fundamentals of Early Stage Investing Book Reflection Week 4

  1. Devon,
    I also believe the “Simple and Easy” methods seem most appropriate for early-stage investment deals. There is so much uncertainty surrounding these environments, so it might be impossible to perform the calculations associated with more complex methods. I particularly liked the clarity and reasoning behind the Berkus Method. It clearly adds value based on specific components in a fair manner. Valuing is the third fundamental of early stage investing and I see subjectivity as a recurring theme. It is definitely nice to see that there are several options to find the most fitting solution to our own environments.
    Good post Devon!
    -Jose F. Saavedra

    Like

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