Valuation: Let’s start from the top

Valuation for early-stage tech startups

One of the more frequent areas of contention when dealing with early-stage technology start-ups as an accelerator that provides funding is the issue of valuation. In the role of Venture Partner at The Baobab Network, one of my biggest areas of learning has been the technical aspects of being in VC. Anytime I’d hear jargon like valuation, Cap table, SAFE or equity, I would get brief dizzy spells before collecting myself. 

I typically learn best in two main ways, (i)) through mimicking, following my “teacher” around and hearing them and (ii) seeing them do the job, the other is being the teacher myself. Teaching forces me to dig deep into all the different elements of a topic and allows me to take that technical thought and translate it into more relatable terminology. 

Now, let’s jump in together and allow me to try to make this simple. 


VALUATION- THE SCIENCE 

Let’s start from the top: valuation, in simple terms, is the current value of your business. In more technical terms it is a quantitative process of determining the fair value of an asset or a firm. Typically it is a financial analysis process that involves experts who use different valuation methods. Examples of these methods include: 

  • Comparable company analysis

This is when you determine your valuation by comparing your start-up to companies with similar attributes; the two main ones are EV( Enterprise Value) and the EBITDA ( Earnings before interest, tax, depreciation and amortization). You ideally will pick companies in the same space, region or space as yourself, and determine the valuation in that way – HERE is more. This is with full understanding that this information in grave detail is scarce and difficult to come upon in Africa, that’s why we at The Baobab Network are keen on doing this work and making this information available, through our research.

The most common type of comparable company analysis is industry multiples. Within some VC firms, they have set multiples (how much more are similar companies selling for in the event of an acquisition, for instance) across industries and would apply it to any business they invest in across any market in the same industry. This mostly applies to later-stage investors, but it’s good to know all the options.

 

  • Precedent transactions analysis

This is a method where you compare your startup to a startup that has been sold or acquired in recent history and apply the same valuation to your own start-up. There is some access to acquisition data albeit there are few of this kind in Africa; especially for early-stage start-ups. The information is also difficult to find, it is worth looking into other emerging markets with similar trends and businesses to form a base. India, Brazil, Mexico, Indonesia, Southeast Asia and Turkey are good places to start.

  • Discounted cash flow (DCF) Analysis 

This one is often used by financial analysts and is best if you have some knowledge of financial modelling. It is based on a finance concept called “The time value of money” which basically states that money is worth more in the present than the same amount in the future. 

This takes into account your projections and then uses a discount rate to determine the value of the company today – The present value. Typically, a financial analyst will create different scenarios to account for risk and push back on the valuation given by the company. In the book Venture Deals by Brad Feld and Jason Mendelson, they say “ The one thing you know for sure about your financial projections at an early stage is that they are wrong” 

This method is definitely overkill for early-stage startups.


VALUATION – THE REALITY 

The reality is, in order to achieve the efficacy of these methods of valuation, you need data. For early-stage start-ups on this continent, this may be hard to come by is data (although our researchers are definitely plugging away at this gap).

That said, you still need to determine a valuation, you just have to do so with a lot more assumptions.  Investors will always push back on this as it gives them better value for money. In the same way, you negotiate every chance you get to save a buck. 

These are the various factors that investors will use to push back on your valuation:

  • Supply and demand – this is a factor of how many start-ups of a similar kind are in your space, your stage and the investor’s jurisdiction. At a time when FinTech is extremely competitive and extremely popular, you could fall either in the low ball category for your valuation, or you’re hot on the market and can dictate valuation.
  • Competitive landscape –  this is based on the availability of similar start-ups in the space and the cost of investing or not investing in them at that stage. For example, if an investor is coming late in the round and there are already strong investors already on the ticket they are bound to take the terms on the table. If there is only one interested investor and many other similar start-ups in the space with more affordable terms you are bound to see a lot more pushback.
  • Perception –  For early-stage start-ups in Africa it is very much a perception game, what do investors feel about your market, what is the overall future of the sector and the approach? What do they feel is your teams capacity to execute? Can they support you for growth? All these things will affect the terms the investor is willing to accept.
  • Data.Data.Data – in later-stage companies there is more information out there on the performance, the EBITDA, the valuation of companies in similar stages. Like I mentioned, what you definitely won’t have is data to compare for early-stage start-ups in Africa. This means that your valuation is almost always set by your lead investor. As mentioned, you can certainly leverage information gathered from other emerging markets like South East Asia and South America. A lot of these markets mimic similar environments to Africa.
    Another great way to gain some insight is to talk to other founders. Leveraging a founder network to understand how they accomplished their valuation.
  • The Exit – Investors of VC firms are called Limited Partners (LPs). LPs are the institutional or individual investors that have invested capital in the funds of the VC. They want to make a return on their money. As such, an agreement is typically made that stipulates the number of years the VC holds the money before repaying it. At which point the VC will exit its position in your start-up. What this means is, they have to be certain that your business can contribute significantly to increasing their return within that period of time.
  • Team – you will always hear the value of a good team  emphasised by investors. The people on your team will sway the confidence investors have in your success. A multi-disciplinary experienced co-founding team and/or previous founders who successfully built a business previously. All the better if your previous start-up was/is successful and you exited or sold. 
  • Traction Metrics – finally, traction. Unless it’s an idea-stage VC they expect to see some traction. This means different things; it could be customer sign-ups, it could be revenue, month-on-month growth, transaction volume, value, early commitments among other things. You have to demonstrate the capacity to execute. 
  • Market size – Your market size and your capacity to expand and duplicate/extend your model to similar markets will also impact the valuation. An easy example is, valuation in Nigeria will be much higher than in Burundi. This is just because of the sheer mass of potential customers in the opposing markets and the markets adjacent to it that share similar qualities. A path to growth must be clear.

My parting shot here is, confidence in your business will definitely change the tone of your conversations with investors influencing the valuation you end up with. You must go into the conversation prepared, know your market and your customer, know your strategy, your execution plan and ensure that confidence is backed by your start-up’s traction and research. A good story is nice, but substance always takes the cake.


The Baobab Network Accelerator Application Banner


Venture partner The Baobab Network Christine Namara

By Christine Namara

Venture Partner at The Baobab Network


The Baobab Network Accelerator Applications Banner


Valuation: Let’s start from the top

valuation for early-stage tech startups

One of the more frequent areas of contention when dealing with early-stage technology start-ups as an accelerator that provides funding is the issue of valuation. In the role of Venture Partner at The Baobab Network, one of my biggest areas of learning has been the technical aspects of being in VC. Anytime I’d hear jargon like valuation, Cap table, SAFE or equity, I would get brief dizzy spells before collecting myself. 

I typically learn best in two main ways, (i)) through mimicking, following my “teacher” around and hearing them and (ii) seeing them do the job, the other is being the teacher myself. Teaching forces me to dig deep into all the different elements of a topic and allows me to take that technical thought and translate it into more relatable terminology. 

Now let’s jump in together and allow me to try to make this simple. 

VALUATION- THE SCIENCE 

Let’s start from the top: valuation, in simple terms, is the current value of your business. In more technical terms it is a quantitative process of determining the fair value of an asset or a firm. Typically it is a financial analysis process that involves experts who use different valuation methods. Examples of these methods include: 

  • Comparable company analysis

This is when you determine your valuation by comparing your start-up to companies with similar attributes; the two main ones are EV( Enterprise Value) and the EBITDA ( Earnings before interest, tax, depreciation and amortization). You ideally will pick companies in the same space, region or space as yourself, and determine the valuation in that way – HERE is more. This is with full understanding that this information in grave detail is scarce and difficult to come upon in Africa, that’s why we at The Baobab Network are keen on doing this work and making this information available, through our research.

The most common type of comparable company analysis is industry multiples. Within some VC firms, they have set multiples (how much more are similar companies selling for in the event of an acquisition, for instance) across industries and would apply it to any business they invest in across any market in the same industry. This mostly applies to later-stage investors, but it’s good to know all the options.

  • Precedent transactions analysis

This is a method where you compare your startup to a startup that has been sold or acquired in recent history and apply the same valuation to your own start-up. There is some access to acquisition data albeit there are few of this kind in Africa; especially for early-stage start-ups. The information is also difficult to find, it is worth looking into other emerging markets with similar trends and businesses to form a base. India, Brazil, Mexico, Indonesia, Southeast Asia and Turkey are good places to start.

  • Discounted cash flow (DCF) Analysis 

This one is often used by financial analysts and is best if you have some knowledge of financial modelling. It is based on a finance concept called “The time value of money” which basically states that money is worth more in the present than the same amount in the future. 

This takes into account your projections and then uses a discount rate to determine the value of the company today – The present value. Typically, a financial analyst will create different scenarios to account for risk and push back on the valuation given by the company. In the book Venture Deals by Brad Feld and Jason Mendelson, they say “ The one thing you know for sure about your financial projections at an early stage is that they are wrong” 

This method is definitely overkill for early-stage startups.



VALUATION – THE REALITY 

One thing you definitely need to achieve the efficacy of the methods above is DATA. For early-stage start-ups on this continent, that’s certainly hard to come by is data (although our researchers are definitely plugging away at this gap).

That said, you still need to determine a valuation, you just have to do so with a lot more assumptions.  Investors will always push back on this as it gives them better value for money. Just as you might negotiate to save a buck at the market.

These are the various factors that investors will use to push back on your valuation:

  • Supply and demand – this is a factor of how many start-ups of a similar kind are in your space, your stage and the investor’s jurisdiction. At a time when FinTech is extremely competitive and extremely popular; you could fall either in the low-ball category for your valuation, or you’re hot on the market and can dictate valuation.
  • Competitive landscape –  this is based on the availability of similar start-ups in the space and the cost of investing, or not investing, in them at that stage. For example, if an investor is coming in the round late and there are already strong investors on the ticket, they are bound to take the terms on the table. If there is only one interested investor and many other similar start-ups in the space with more affordable terms, you are bound to see a lot more pushback.
  • Perception –  For early-stage start-ups in Africa it is very much a perception game, what do investors feel about your market? What is the overall future of the sector and the approach? What do they feel is your teams capacity to execute? Can they support you for growth? All these things will affect the terms the investor is willing to accept.
  • Data.Data.Data – in later-stage companies there is more information out there on the performance, the EBITDA, the valuation of companies in similar stages. Like I mentioned, what you may lack is data to compare for early-stage start-ups in Africa. This means that your valuation is almost always set by your lead investor. Again, you can certainly leverage information gathered from other emerging markets like South East Asia and South America. A lot of these markets mimic similar environments to Africa.
    Another great way to gain some insight is to talk to other founders. Leveraging a founder network to understand how they accomplished their valuation.
  • The Exit – investors of VC firms are called Limited Partners (LPs). LPs are the institutional or individual investors that have invested capital in the funds of the VC. They want to make a return on their money. As such, an agreement is typically made that stipulates the number of years the VC holds the money before repaying it. At this point, the VC will exit its position in your start-up. What this means is, they have to be certain that your business can contribute significantly to increasing their return within that period of time.
  • Team – This one you will always hear from investors. The people on your team will sway the confidence investors have in your success. A multi-disciplinary experienced co-founding team and/or previous founders who successfully built a business previously. All the better if your previous start-up was/is successful and you exited or sold. 
  • Traction Metrics – finally, traction. Unless it’s an idea-stage VC they expect to see some traction, and this means different things. It could be customer sign-ups, it could be revenue, month-on-month growth, transaction volume, value, early commitments, among other things. You have to demonstrate the capacity to execute. 
  • Market size – Your market size and your capacity to expand and duplicate/extend your model to similar markets will also impact the valuation. An easy example is, valuation in Nigeria will be much higher than in Burundi, just from the sheer mass of potential customers in the opposing markets and the markets adjacent to it that share similar qualities. A path to growth must be clear.

My parting shot here is, confidence in your business will definitely change the tone of your conversations with investors influencing the valuation you end up with. You must go into the conversation prepared, know your market and your customer, know your strategy, your execution plan and ensure that confidence is backed by your start-up’s traction and research. A good story is nice, but substance always takes the cake.


The Baobab Network Accelerator Application Banner


By Christine Namara

Venture Partner at The Baobab Network


The Baobab Network Accelerator Applications Banner