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Why Early-Stagers Need Valuations
Understanding the true value of your business is critical during the due diligence stage of the M&A process or perhaps when you have other specific purposes, which could be related to tax or marriage dissolution. However, as an entrepreneur, it’s important to understand, as well, the importance of appraising your startup or early-stage business.
Without any historical financial data, valuing startups or early-stage businesses could be tricky. Our guest, Pieter Stam, a professional valuation consultant from an Amsterdam-based company, Troostvijk, discusses why and how a valuation could benefit startups or early-stage businesses.
Questions Answered For You
- Why should owners of startups or early-stage businesses have their companies appraised at such an early point?
- Although all businesses are different, are there common value drivers that owners need to focus on at the initial stage of the business operation?
- What are some examples of intangible assets that are essential during a startup or early-stage valuation process?
- What can new businesses do now to work toward improving the value of their companies at the very early stages?
Why seeking financing from banks is not the best option: "Banks don't add any other value, and a majority of the time, they're just money. If you have a venture capitalist or private equity … if they invest, you can access their networks. Maybe they will be able to give you the first traction. It becomes easier to enter the market."
Key Takeaways To Remember
- A company’s intangible assets are critical in the appraisal of startups or early-stage businesses. The most important intangible asset is the management. You can have the best idea in the world, but “without proper execution, you're absolutely nowhere.”
- The most important value driver in a startup or early-stage business is traction – the momentum or progress your business has made.
- When seeking business financing, entrepreneurs should consider private equity or venture capitalists more than banks. Unlike private equities, banks don’t necessarily add value to your startup or early-stage business.
From our studio in Southern California, with guest experts from across the country and around the world, this is "Deal Talk," brought to you by Morgan & Westfield, nationwide leader in business sales and appraisals. Now, here's your host, Jeff Allen.
Jeff: Hello and welcome back to the web's number one content source for small business owners committed to building a business for eventual sale. Here on "Deal Talk" it's our mission to provide information and guidance from our growing list of trusted experts that you and all small business owners can use to help you build your bottom line and improve your company's value.
We know that many listeners to this program "Deal Talk" have their own businesses that are just getting off the ground or starting to show their first signs of their measurable growth. If that's you, congratulations. And since we're all about helping you raise the value of your company, we wanted to have someone join us who can talk about working with young businesses, startups or at least age ventures etc., to help them establish their values at an early stage. And to do this I'm happy to be joined by Mr. Pieter Stam, a professional business appraiser who specializes in valuations for newer companies. And he joins us from his office near Amsterdam in the Netherlands. Pieter Stam, welcome to "Deal Talk," sir, it's good to have you.
Pieter: Thank you very much. Thank you.
Jeff: Pieter, let's start by talking a little bit about you. There in the Netherlands we don't have a lot of contacts from the program. We've interviewed a couple of valuation consultants and also professionals in the M&A space from your country recently on the program, but let's learn a little bit more about you and what your area of specialty is, and the companies that you help as well.
Pieter: My background is basically I used to consult companies in turn around management and how to recover or restructure assets. After my masters I was basically headhunted to value companies in all stages of their life cycle. Particularly what I do is I try to simulate in a way the future. For that you need to have some of course … the normal … this kind of cash flow modeling. But also you have to put in strategic knowledge. Where do you think the company can be in a certain amount of time, and what is a normal horizon?
If you take a look at the whole value of a company, you subtract the debt and the assets, you're basically stuck with the intangibles.
Jeff: Why should the owner of a startup venture or an early stage business have their business appraised at such an early point in its existence?
Pieter: The most straightforward answer is probably to seek financing. But that is not nearly the most important thing. There are two things that I think that are really important. If you're at the very early stage, you have to make huge decisions. How will I enter the market, what is the market, who are my customers, etc. No valuation behind it. It will give you support with the strategic choices you have to make basically.
And on the other hand, if you're still in the early stage but you already invested a lot of effort and resources, it's a way to value these efforts. And sometimes you want to take off shares from the other shareholders and you have to have a point in time to know what is it worth. And I think those things are really important because, for instance, what I tend to do is a majority of the time I do just discounted cash flow models. And sometimes enrich it with a Monte Carlo simulation.
Jeff: Tell us what that Monte Carlo simulation is. We've heard it discussed here before, but if you could provide us with some information as to why that's important.
Pieter: The Monte Carlo is a place in Monaco and they're famous for their big casinos, and that's where the name is coming from. It's like rolling the dice. If you have two dice in your hand the biggest chance that you throw is seven. But what happens if you throw a five or an eight? If you have a large cash flow model with a lot of uncertainties, you can simulate them.
So you can say, "Probably my market is growing with X rate, or my customers I will penetrate a new market so I expect." But what happens if those things aren't playing out? So you can say, "This is the bad case and this is the best case." So you know the bandwidth of the value of your decision making. And of course it's not like a hardcore science, but it gives you the idea and some know-how, which are good decisions and what's the impact of it.
Jeff: Pieter, can you tell me if the act of having a business valuation itself, the process of having a business valuation, that first one, is that something that can actually not just result in improved value but can that actually improve the value of a company itself if a company has taken the time to have their business appraised right from the start?
Pieter: Yes, definitely, because if you know the choices that you can make, all the possibilities, and you get consoled about those options in an early stage. And that's very difficult, because in that early stage businesses don't have money. But if they seek finance, and what we see here if you want finance you want to get finance from a bank, for instance, which I don't recommend for any early venture by the way. They want to have something more than just idea. The banks they need to have value.
So in that whole process of putting a value on their intangible assets, in a way it's just an idea or it's just a group of people that are very intelligent. Even though they're probably very skilled, they still have to know what the result will be in a way from their decision making.
Jeff: So the intangible assets that really you're measuring in terms of value and providing that valuation to them, these are even more important aren't they when we're talking about appraising new, young, early stage businesses or startups. The intangible assets are probably more important in this particular case than they would be for an established company that has been in business for 10, 15, 25 years is that right?
Pieter: Yes, that's definitely right. When I appraise the business I tend to appraise the asset. I'm not interested in their depth structure or their... I tend to first take a look at, all right, what are just the assets worth, besides the whole structure having access to grapple the market or whatever. Because the assets itself and particularly the intangible assets, that is the real value of a company.
Jeff: We've been told that valuations are not necessarily just a measure of past performance and of the value of a company to the present date, but rather also forward looking as well, and can include potential... Is that true? Explain how that works.
Pieter: A lot of people that tend to look at a company, this is their track record. I expect the track record to be the same. And if the GDP is growing it will grow at the same rate. For instance, that's what you see with more mature companies, but with a startup or even an early stage venture you see that you have to anticipate on the future because you don't have that much history. And a majority of the time they're not making a profit. You can simulate what happened to see... For instance, we see when do they have enough mass to start making a profit. And you can use basically a multi-current simulation for that.
Sometimes I have to tell people, "I don't think your idea's good enough. Or your business model is just broken. Maybe you should do something different. Be surprising. Enter the market in a different way." Sometimes I see businesses, they reinvent something but they don't do it better. They think they could do it better but the customer isn't thinking that way. So for me one of the most important factors is probably for early stage ventures that they have already traction, like the first customers. If it's a really early stage you can still tweak the product or the service. I think that is definitely important if you want to...
Jeff: Let me ask you this, Pieter Stam, what kind of reaction do you get from those individuals that you speak with, and you have to meet with these people and discuss what's driving their business, or discuss their product like you talked about or their service. And you tell them, "You know what, this isn't really working, or the potential here for failure certainly does exist if certain things aren't corrected."
What kind of response do you get from them? Are people generally disappointed? Are they genuinely interested in hearing what you have to say? Just kind of give us some kind of indication of what reactions you've had to deal with in the past.
Pieter: Of course people are a bit disappointed, because they put a lot of effort in it and a majority of the time they're really passionate about the product. But if you report in such a fashion that they understand every step of a simulation of the valuation process you can point out the weaknesses. And of course they're not only weaknesses, sometimes the idea is great but the management team, for instance, is not good enough. There's always a way that they can stir it a bit. But sometimes they put in a lot of effort and it's worth basically nothing.
A good plan needs good execution. But along the way you find things that you have to change, or the market is changing, or you are changing. So you always have to keep in mind what is the dot on the horizon where I'm going.
Jeff: And it's what it is. And they continue to move forward with their original plans whether or not their plans would be able to result in anything tangible in terms of success. This is a great place to stop for just a moment because I want to take a break. And when we come back, Pieter, I want to be able to chat with you about value drivers and about these intangible assets in a little bit more detail to kind of get your take on some of the drivers and intangibles that you actually talk with these companies about and how they can start to make efforts to improve the value of their company and steer the ship in the right direction. My name is Jeff Allen, and I'll be back with Pieter Stam. He is a valuation professional based in the Amsterdam area in the Netherlands, and we'll continue our conversation when "Deal Talk" continues in just a moment.
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Jeff: My name is Jeff Allen with Pieter Stam. He's a professional valuation consultant coming to us from Amsterdam today. And we're talking about the importance of valuations, business appraisals for new, young companies. We talk about oftentimes valuations, the importance of value drivers and we're going to start this second segment of this program by talking about that right now.
Pieter, you've mentioned that when you're called in to appraise these businesses you're going to visit with these clients and then you will sit down with them oftentimes and provide your feedback, and let them know about ways that they can approve some things that they need to do in order to gain the growth, to get on the path, the trajectory to growth in the future. Let's talk about some of these important value drivers right now for young companies. I know that all businesses are different, but are there some value drivers that you come back to again and again to discuss with these companies and things they really need to focus on in the beginning?
Pieter: Yeah, definitely. And it's not that special. The most important value driver I guess is traction. Do you have first customers, do you have first feedback on your product and services? The whole idea... Can you keep on improving what you're doing? The majority of them that's the most important thing.
And of course you have things like patterns, you have maybe brand names, or like proper social media exposure. Those things are important to create a buzz around you. But the most important thing is probably traction. You just need to have your first customers and have your first starting up the whole business. Because you go from an idea to have them serving and resolving problems. That is probably the most important thing.
Jeff: One of your specialties is obviously it's appraising intangible assets and you explained why that is very, very clearly in the first segment of the program. What are some examples of intangible assets that you can describe for us?
Pieter: I think the most important intangible asset is probably the management. And it sounds really strange because you can have a great idea but without proper execution you have nothing, really have nothing. And there is a famous quote and it's called betting on the horse or the jockey. The horse is the starter basically and the jockey is management. You can have the best horse in the world, you have the best idea, but without proper execution you're absolutely nowhere.
That's probably the most important intangible asset. But of course you have the whole process of R&D or the whole being able to attract new challenge. Those things are really things that you don't see on your balance sheets basically. If you take a look at the whole value of a company, you subtract the debt and the assets, you're basically stuck with the intangibles. And from there on you see that the whole things like the know-how, the good will, the brand name, the reputation. And when someone wants to buy a company or you want to have new shareholder, or getting equity financing, those things matter a lot.
Jeff: Let's go back to what you'd mentioned a short time ago about new companies and that they should not seek financing from a bank in the beginning. Can you tell us why that is?
Pieter: That's because banks they don't add any other value, and a majority of the time they're just money. And money by itself is not interesting at all. It's like if you have a venture capitalist, or private equity, or whatever, if they invest you can access their networks. Maybe they will be able to give you the first traction. It becomes easier to enter the market. And there's scientific evidence that companies that get funded by private equities they probably enter the market quicker, they are more successful. Because private equities, when they do their due diligence and they think, "We can make a profit out of it," that is by itself already a value a driver. Because if private equity doesn't want to invest in it, probably it's not a good company.
Jeff: This conversation with Pieter Stam has really been very interesting and very eye-opening indeed from someone who obviously, a former new startup business owner myself, it's been many years in the making now. But had I known then what I know now I probably would've been a much smarter individual from the beginning. Pieter, I want to wrap up this segment of "Deal Talk" by asking you if you can leave us with a few parting words, some final thoughts, recommendations that you have for new business owners, new entrepreneurs. Maybe they've just launched their companies, maybe they've been in business for a year or two. What can new businesses do now, young businesses do right now to work toward improving the value of their companies at the very early stages?
Pieter: The thing with the valuation of a company, in a sense it's very subjective because, like I mentioned before, if you get backed by private equity they provide more value than just money. They help you in other ways if they're the proper investor.
That's a thing that probably you have to always keep in mind. So if someone gives you a value of your startup, or your early stage venture, or whatever, you always have to take a look at how they made the valuation. Because in my case I make a forecast. And if you take a look at the forecast you have to make a lot of assumptions. And if he or she is doing a good job the assumptions make sense, you can learn a lot from a valuation in such a fashion.
If you do it at an early stage, which is quite funny if you're an early staged venture. You can still pull some strings to redirect your venture and do maybe some bit of difference to teaching decision making. And I just think that a good plan needs good execution. But along the way you find things that you have to change, or the market is changing, or you are changing. So you always have to keep in mind what is the dot on the horizon where I'm going. And I think that's probably the most important thing.
Jeff: Pieter Stam, this has been, like I said, an eye-opening conversation. We appreciate your time. We really enjoyed it. And hopefully in the near future we can have you back on the program again. Thank you so much once again for joining us today.
Pieter: Thank you.
If someone gives you a value of your startup, or your early stage venture, or whatever, you always have to take a look at how they made the valuation.
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