- Last Updated: 21 January 2015 21 January 2015
Jack Delosa, a entrepreneur, published "10 reasons why investors steer clear of start-ups" in The Age. Read it, and you'll see the importance of integrating valuation and plan.
Delosa's ten points are all excellent. To simplify, they can be grouped into
- operations (such as management team experience)
- proof of the pudding (show that you can win customers and that you are have a "revenue model")
- financials: cash flow and valuation, exit
- growth path: focus on the market opportunity, build strategic assets
We'll explain how the business plan can address these points, and show why valuation is so crucial to a credible and convincing business plan.
One of Delosa's tips is "Raise as little money as possible in the beginning. Prove the concept, establish a higher valuation, then raise more for less.". If you're financing with equity (ie, via the sale of shares), this is classic multi-round funding. As he says, you use a small amount of cash to raise the business to the next level, which increases the valuation. That is, the price per share increases.The founders of the company own the most shares, so they benefit from this. It also encourages the first round investors: when the second round is executed, they've made a nice paper profit.
One point that Delosa hints at but does not make explicit is the "Use of shareholder Funds": be very clear when telling your investors how their cash will be used to grow the business. Telling investors that you'll use the money to repay loans to founders is not a good look. Investors need to know that the funds will be applied to the growth path, to raise the valuation of the company in time for the second round of fund raising. The funds may be used to commercialise a product, for example.
We've made a Google spreadsheet to show how this works. It's accessed here: http://goo.gl/ZUt3w
In this example, the founders decide the company is worth $500,000 and they divide the shares between them. This valuation is not very meaningful, because it hasn't been tested: no third-party money has changed hands in return for shares.
That happens at round 1. The founders raise $200,000 for 20%. This now a valuation to the business, and it dilutes the original shares.
Later, a second round is raised. In this example, it's for another $200,000, but the round 2 investors are persuaded to pay $200K to buy only 5%. The implied value of the company is shown in the spreadsheet, both as a total figure and a price per share.
This magic is possible because the first $200K was successfully used to move the business along: get some sales and prove the business model (see Delosa's article).
In his article, valuation and cash flow are a recurring theme.
Reason 4 for "why investors steer clear of start-ups" is bluntly titled "No understanding of valuation".
Many business owners think valuation is an outcome of how much money they want versus how much equity they want to give away. Both these factors are, in many ways, irrelevant to the investor. The business owner needs to have a clear indication of what the business is worth and this needs to be backed up by a clear valuation methodology.
This is why GrowthPath makes business plans and valuation models in parallel. They can't be separated if you want to convince investors or lenders of your business opportunity. We call it the "IVN" approach to business plans: The Integrated Valuation and Narrative approach.
Read more about GrowthPath's IVN Business Plans