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Home / Business / Financing / Venture Capital

How Do Investors Value Start-up companies?

By:Dee Power

Entrepreneurs and investors, both venture capitalists and angel (private) investors have very different perspectives when it comes to determining the value of an early stage company. Contrary to what a number of entrepreneurs think, investors aren't greedy, manipulative, vultures -- well, most of them
aren't anyway. So how do VCs and angel investors come up with their valuations? What are the most critical factors in that all important decision?

Over 100 entrepreneurs that were actively trying to find capital were asked what they thought the most important factors were to VCs and their results compared to what venture capital firms and angel investors actually said were the most important factors.

Respondents were asked to rank the following factors from 1-least important
to 9-most important:

Growth potential
Barriers to competition
Return on Investment ROI
Size of market
Stage of the company
Industry of the company

"Quality of Management' was the number one factor for angels, entrepreneurs and venture capitalists. 'Stage of Development', and 'Industry' are ranked in last places by all three as well. The greed factor, or ROI - return on investment, is ranked in seventh place by angels and tied for fourth place by VCs.

Surprisingly, entrepreneurs had very little variation in rank from the top factor to the bottom, only six tenths of one point comprises the difference in the average rank from the top factor to the last place factor. The range for angels is 3.3 points. Entrepreneurs considered 'Quality of Management' the top factor but not by much. With each of the factors, a significant number of entrepreneurs said it was most important, and a significant number said it was the least. Even in the case of 'Quality of Management' roughly 40% of the respondents ranked it 9 or 8, and 30% ranked it 1 or 2 in importance. Well over half of the Angels rated management as the most important factor and 60% gave it a 9 or 8 and only 10% gave it a 1or 2 in importance.

The data shows that many entrepreneurs just aren't sure what factors are most important. Many of them gave all the factors a 6 or 7, for example, indicating all the factors were of significance. Or perhaps they just couldn't decide or didn't know which factor was the most important so rated all of them in the
middle range.

The fact that entrepreneurs, who sometimes are accused of being too much in love with their product, ranked product uniqueness lower than other key factors, was a positive thing to see. Product narcissism can lead entrepreneurs to forget to explain a key factor to prospective investors: How are you going to sell
this thing?

Entrepreneurs' experience with angels tells them that angels are very individualistic in how they analyze potential investments. It is up to the entrepreneur to determine what factors are most important to a given investor and make sure the factors are addressed in the discussions the entrepreneur has with the investor.

So how do entrepreneurs take the bite out of valuations?
Entrepreneurs need to demonstrate the quality of their management team, focus on the growth potential of their company, define their market and prove that the size of the market is large, and of course, show that their unique product or service fills a need in the market.

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Article keywords: angel investors

Article Source:

Dee Power is the author of several nonfiction books and the novel "Over Time" about Green Bay Football. Money, Love and Football: All the Important Things in Life. She and her partner have developed the Capital Connection website to provide small business financing resources, including private investors, venture capital and loans to entrepreneurs.

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