What You Need to Know About Angel Investment Valuation
Let us dive into the intricacies of angel investment and valuation for angel investment with this article.
We have gained a lot more knowledge about the startup ecosystem in the last ten years. Unicorns, stealth mode, capital raising, and exiting are becoming common phrases. The practice of angel investment has also grown significantly. The majority of investors would want to think of themselves as rational individuals, although inspiration and emotion are frequently prevalent in the world of innovation and business. Investors are also people, including business angels. So, some psychological elements may be affecting corporate investment decisions. Angel investors have increased their bet size in the wake of well-known successes like Uber, WhatsApp, and Facebook in the expectation of achieving large profits. Let us dive into the intricacies of angel investment and valuation for angel investment with this article.
Angel investment valuation
The term “Angel” was first used in the Broadway theatre, where wealthy patrons contributed funds for theatrical shows. After finishing a study on how entrepreneurs obtained financing for enterprises, William Wetzel, the founder of the Centre for Venture Research and a professor at the University of New Hampshire, invented the phrase “Angel Investor” in 1978. He used the phrase to refer to financiers who provided startup companies with seed money.
What is angel investment?
Angel investment is the type of investment through which high-net-worth individuals support small companies, or entrepreneurs financially. They are known as angel investors, private investors or seed investors. These individuals often do so in exchange for ownership of stock in the startup or entrepreneur’s business.
Angel investors frequently invest in the entrepreneur launching the business rather than its viability. Thus, having an angel investment for your company offers more favourable conditions than traditional lenders. Instead of concentrating on the potential wealth they might make from the business, angel investors help companies reach their growth from ground zero. According to Forbes, 70,000 companies received $25 billion from angel investments in 2017.
Advantages and disadvantages of angel investment
It is wise to know the advantages and disadvantages of angel investment before pursuing an angel investor.
There is less risk involved than getting a small company loan, which is the main advantage of angel investment. In contrast to loans, angel investors provide cash in return for stock. Thus there is no obligation to repay them. Angel investors frequently have prior investment experience. They have a long-term perspective and are aware that it may take a while before they see a return on their investment. Other advantages include connections with investment bankers, accountants, and other experts; credibility from being linked with the investor; knowledge of the market and tactics utilised by comparable businesses; mentoring, direction, and insightful information for the startup.
Although angel investors help entrepreneurs expand their enterprises, this kind of capital has certain drawbacks. Loss of equity is one of them. Several business owners offer between 10% and 50% shares of their startups. A high rate of return on investment is something that angel investors could also hope for, frequently up to tenfold in the first five to seven years. This could increase the pressure on the company and its promoters. It’s crucial to establish growth expectations before accepting investment and to ascertain whether the company can expand at the rate that investors would anticipate. The loss of business control is another negative aspect of angel investment. Most angel investors actively participate in the business after investing in a startup.
What is angel investment valuation?
When talking about how much money an angel investor is willing to put into a firm, the term “angel round valuation” would be used. Obtaining capital from angel investors requires you to have a firm grasp of your company’s valuation since they will conduct a thorough analysis of the company before committing any funds. While looking for angel investors, one of the most crucial steps is determining how much your firm is worth. Startups are notoriously difficult to value accurately since they typically have yet to generate any revenue, which makes the process vastly different from that of valuing an established business that is already making money.
The scorecard valuation approach is often used by angel investors to determine whether or not a company is worth investing in. By using this technique, your firm will be compared to others like it that have already obtained investment, with consideration given to factors like the market for your product and the region in which your business operates. Investors using the scorecard approach will first check for the median value of comparable startups. Although the scorecard approach might not give you a firm valuation, it can be a helpful tool for angel investors to utilize in deciding whether or not to put money into a startup that has yet to generate revenue.
Yet other methods are Pre-Money Valuation and Post-Money Valuation. Pre-Money valuation is the value of the business before any financing or angel investment. It indicates the value of a startup before securing funding. Post-money valuation describes the value of a company following funding. This will be the value after an angel investor has funded the company.
There are certain axioms that investors follow during angel investment valuation. Before investing, angel investors will carefully review a company’s value. Thus, knowing how much your firm is worth is crucial if you need money. When establishing the valuation for angel investment before a startup generates income, angel investors take several criteria into account. They take into account the entrepreneur’s background, their expectations of the overall investment possibility, and the startup’s requested funding.
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Benefits of angel investment valuation
In a round of funding for seed and early-stage businesses, angel investors typically contribute between $25,000 and $100,000 per investor. The typical round size is between $250,000 and $1 million, with a $1 million to $3 million range for firm valuations. In terms of market competition, asset values, and income values, a business valuation for angel investment gives the owner of the firm a variety of data and numbers about the true worth or value of the company. Thus, angel investment valuation proves to be beneficial as it helps the startup in gaining the best value from the investment. Also, when using qualitative data, it is challenging to forecast a startup’s prospective success. As a result, angel investors base their choice on the value they place on the business’s proprietors.
How does angel investment valuation work?
The experience of the management team, the company’s assets, the inventiveness of its technology, particularly its intellectual property, and the market environment decide the valuation for angel investment. The projected return for investors and shareholders is ultimately largely determined by the valuation.
Investors frequently discuss a company’s pre-money or post-money valuation at the time of their investment. This computation can be simple if all an investor receives in return for the investment is a certain percentage of the common stock.
Nonetheless, angel investors have learned from venture capitalists to bargain for preferred stock rather than common stock as the sort of security for their investments as well as for other financing conditions, including board seats, controls, warrants, and dividends. When these circumstances exist, valuation at the moment of investment becomes complicated to quantify. Implicit and explicit valuations are used for fair quantification.
How do angel investors value startups?
When determining whether or not to invest in a company, the majority of angel investors prefer to employ the scorecard valuation technique. This approach compares one startup to other comparable startups that have already obtained investment, taking into consideration factors like the location of your business and the market for your product. Investors will initially check for the average worth of businesses similar to your own using the scorecard approach.
For an angel investment, the startup’s valuation will be compared to those of other businesses using variables like the management team’s background, chances of your startup to be successful, details of your product, potential competitions, marketing plan and sales outlets, and any additional investments your startup might require.
Ways to value startups for angel investment
The startup’s value before receiving outside funding can be determined in a variety of ways. Thus, it is advisable to get familiar with valuation techniques from other business owners and angel investors. Understanding every technique will only enable you to bargain your valuation with investors. Three ways to value startup for angel investment are listed below:
The Berkus Method determines valuation based on five components using both qualitative and quantitative factors:
- Sound idea
- Working Prototype to reduce technology risk
- Quality Management Team to reduce execution risk
- Quality Board of Directors
- Rollout of a product or sales to reduce production risk
Scorecard valuation method
One of the techniques most frequently employed by angel investors is the Scorecard Valuation, sometimes referred to as the Bill Payne valuation method. This approach modifies the average valuation based on variables like market, region, and stage to compare the startup to other financed startups.
Finding the typical pre-money valuation for early-stage firms is the first step. Pre-money valuations across regions are frequently examined by angel groups as a solid starting point. The second phase is to assess how the startup stacks up against other businesses in the same area. Finally, the percentage weights are calculated.
Venture capital method
Bill Sahlman, a professor at Harvard Business School, is credited with popularising the Venture Capital Method in 1987. This method establishes post-money valuation using industry criteria before moving on to pre-money valuation.
The procedure is based on the following equations:
- Post-money valuation = Terminal value ÷ Expected Return on Investment (ROI)
- Pre-money valuation = Post-money valuation — Investment
Where ‘Terminal value’ is the predicted value of an asset at a specific future date and ‘Expected Return on Investment’ is the estimated return on investment for investors in the business.
Factors that Affect Angel Investment Valuation
Several factors affect the valuation of angel investment. The following factors greatly affect the valuation of your startup:
- Stage of the company
- Market demand for the company’s product/service
- Competition in the industry
- Financial performance and projections
- Quality of management and leadership
To get the best of the deal, your startup should ensure to be on the positive end of the above-mentioned factors. For instance, angel investors are frequently drawn to ideas that address significant problems for a wide range of target markets.
Challenges in Angel Investment Valuation
According to the Center for the Advancement of Social Entrepreneurship (CASE), angel investment valuations have certain challenges. These challenges are direct consequences of their business models and economic contexts.
The business model challenges include:
- Attaining corporate sustainability
- Keeping a competent leadership team in place
- Investigating funding options
The economic context-related challenges are:
- Absence of early-stage investing legislative frameworks
- Prejudices against local early-stage investing
- A general lack of knowledge, experience, and skills in a small market
Get your investment valuation from Eqvista!
Angel investors are adept at spotting businesses that have the potential for the growth they seek. Getting an angel investment for your startup confirms that you are moving towards accomplishing your ambition. Precise valuation is equally important, and Eqvista can help with your angel investment valuation with experienced valuation specialists who are knowledgeable about every industry. Contact us now for more details.