Are Angels in Denial About Exit Valuation?

Are Angels in Denial About Exit Valuation?

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There are three variable that drive the financial return for Angel investors (and founders):

  • Pre-Money Valuation.
  • Subsequent Dilution.
  • Exit Amount.

Instinctively founders seek as high a valuation as possible. It must be a ‘good thing’ to ‘give away’ as little equity as possible. Typically, founders will seek to find comparatives to justify their valuation proposals. If company X is worth $6m then we must be too.  (Let’s put aside for the moment that the comparative being used is likely on a different continent, and probably has quite a different set of skills in its team, different experience in its founders, and different intellectual property).

And it seems many investors have been going along with this. Perhaps out of fear of losing out on ‘the best’ deals – though I have yet to meet anyone who can actually pick winners at the first round (or follow on actually) – if angels could do that then presumably the percentage of their portfolios that fail to return capital would be less than 70%.

A big part sems to be a failure to think strategically about a deal – looking not just at a first-round valuation, but at the total cash that business is going to need to get to an exit (and the resulting dilution on their ownership %), and the actual likely exit value achievable.

And this in turn is likely significantly due to the media fixation of Unicorns. Without appreciating that it’s the valuation of most unicorns that is a fantasy. Because so much talk is about $1bn companies that’s become the perceived normal – the bar against which all else is measured – and found wanting.  But over the last 10 years just 1.7% of all UK high growth company exits have achieved a value of $1bn or more.

The unicorn culture has stopped people talking about, and admitting to, the reality – most exits are much, much smaller. And no, its not because we lack ambition in the UK – the exit values in the USA are largely at the same level. As with most commercial transactions the buyers have a price band they are comfortable paying. Trying to ‘scale’ past this comfort zone (which is a reflection of the acquirer’s commercial reality) is more likely to create a non-exitable company – and certainly massively dilute the early investors, and probably the founders as well – than crate added exit value.

Triple Point and Beauhurst have produced a report looking at 2,724 exited UK companies between 2011 and 2019[1]. Of these they have exit value data on 604. It’s likely the bulk of the non-disclosed deal values will be at smaller values. Big deals are publicly announced (either publicly or in financial accounts). Small deal value announcements are likely inhibited by embarrassment under the prevailing unicorn culture.

The data shows that 87% of exit values are under £200m. But digging deeper, 51% are at £30m or less.

Most Exits are ‘Small’. www.beauhurst.com/research/Exits-in-the-UK

This is not a reflection of lack of ambition by UK founders – or a lack of UK scale up capital. The 2016 ‘Global Tech Exit Valuations’ report by CB Insights showed 54% of exits globally were at $50m or less (and they also pointed to the fact that the majority of smaller exit values are not made public, so that figure will likely be significantly overstated). Rob Witbank’s study presented to the American Angel Capital Association conference (ACA) suggested that 87% of US exit values were $50m or less (perhaps significantly impacted by the high level of ‘acquihire’ transactions, where a large tech company purchaser a small tech company just to get the technical team – the acquired company being quickly shut down. The technical skills of the team being seen as more valuable to the likes of Google than the  product they were working on).

Exit value is critical in determining the financial return on all investments made into a company, including the very first. It’s hard to see how you can get the target 10x return from a deal (the generally agreed target needed to archive a 2 – 3x return at portfolio level given the very high, 70%, level of deals that will produce a negative return) if the first round valuation is north of £3 million, and the probable exit vale will be sub £50 million (even without considering any future funding dilution, or preferential returns introduced by subsequent funders).

The report shows that 97% of exits have been via an acquisition (as opposed to an IPO), and the average acquisition exit value has remained unchanged over the past ten years. Yet data from Pitch Book shows entry valuations have been significantly increasing in the UK, with Angel and seed valuations rising from about £1 million in 2010 to £3 million in 2019.



Mean Acquisition Exit Values Flat over 10 years.
www.beauhurst.com/research/Exits-in-the-UK

There is no rational reason to accept an increase in entry valuations of 3x while exit values have remained flat. Perhaps it supply and demand – all that SEIS / EIS incentivised (dumb money) investment chasing quick deals to beat the tax deadlines. Perhaps it’s that before COVID chased them away Angel tourists thought it was cool to get into some ‘hot’ deals. Perhaps we investors have just not been looking for, and using, the realities of the data to negotiates sensible valuations, and been willing to walk away from the daft ones.

How do you calculate the ‘correct’ valuation? Comparatives have some merit, providing you are using a genuine comparative. Don’t go comparing your e commerce, shoe comparison site with a San Diego Biotech company.  The Score Card method can help focus on the key issues to be used in due diligence, but if the management team is not excellent, you don’t compensate by lowering the valuation. You just don’t do the deal.

Truth is, startups have no value. How can they, if 70% end up failing to return capital (and obviously we don’t know which are in the 70%!). The 70% are probably worth less than zero at initial funding – because your going to lose money on them.

So how does valuation actually work? The early investors need to take 20-30% ownership to manage future dilution and have a decent ownership at exit, to derive that 10x potential return. This assumes a reasonable level of investment is going in, depending on location, say $100,000+. The valuation is derived based on that percentage, and the amount of funding the company needs to achieve credible, critical value add mile stones. If the company needs £500,000, and the investors take 25%, the post money valuation is £200,0000, and the pre £1,500.000. If the company needs £700,000, that valuation is £2.8m.

(The founders get the balance of ownership, less the 15% or so that is popped into the share option pool. Always get that set up at the time of your first investment – otherwise it will add further dilution when the next investor require it).

Is that £2 million valuation sensible? Depends on how much more cash needs to go in to get to exit, and the resulting dilution on the investors. That needs to be modelled on a future looking cap table, showing each expected future round, amount, valuation and dilution effect.

And then look to see what is the probability of achieving an exit big enough to get a 10x return. In simplistic terms, a £2 million entry with no further funding or dilution needs a £20 million exit. The data we have above suggest that 62% of exits are at values above £20m. Reasonable odds, as long as there is no more dilution. But it’s a rare company indeed that gets to exit, especially above £20 million, on a single round of funding.

This suggest that you would likely not want to be going above a £2 million valuation. And yet clearly the data indicates that investors regularly are. Perhaps all the higher valuations are for companies that are just that much more ‘special’.

Valuation is important, and does need to be considered in conjunction with future capital needs, dilution and the realities of exit value. Exit values of genuine comparatives, of similar companies in the same geography. And investing on the same terms. A valuation of £3 million is a very different value when the investor has a 3x preferential return built in.


[1] www.beauhurst.com/research/Exits-in-the-UK

The Valuation Myth – Part 1

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I was asked recently to provide some feedback on possible valuation benchmarks for a company raising its first external equity funding.

Of course the funder has been looking at valuations from Silicon Valley. Largely one suspects because they are larger than the local ones in Latvia.

The use of comparatives is a sensible way to benchmark valuations – what valuations have been achieved by similar companies?

But they are usually used badly – because the definition of what is ‘similar’ is too narrow.

Similar is not only (or indeed primarily) those in a similar industry or tech vertical.  

What is more critical are factors such as:

  • Achievements to date – critically customer engagement and meaningful revenue generation.
  • Levels of actual Intellectual property (patents applied for, granted and freedom to operate reports).
  • Experience of the management team – have they previously successfully built and exited a company?

Comparatives ignore the most critical influencers of future value for early investors.  For investors the return on investment is driven by three factors:

  • How much ownership of the company you have at initial investment (the outcome of the initial valuation).
  • How much ownership you have at exit – a function of dilution – how much more money will the company need to get to an exit, and how much of that will the initial investors be able to provide?
  • The actual exit value achieved.

Investors who only look at the first of these – the initial valuation, are likely to do badly in the end.

Providing $200,000 for 10% of the company (which gives a pre money valuation of $1.8 million, is meaningless, unless we know what future dilution we will suffer. Say the company needs $100 million of VC money to get to the exit – what ownership will you then have? And even if you have say 1%, if the VC’s have just a 1x preference, then unless the company sells for at least $100m, you will not get one penny back (did I mention that most successful exits are for around $25m – $35m?).

Valuation is not about what a company is worth today – or indeed what it is going to be worth on exit – but what ownership percentage you will have at the time of exit, and what the terms of that exit are. Those terms will not be set by you – but by the provider of the last round of funding.

Valuation therefore begins with a deep analysis of Comparatives – the comparative of EXIT values and the total funding that has been required to achieve them.

Strategic Angel Investing – Rarely Understood

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As an Investor your financial returns will be driven by the following factors:

  1. Initial Valuation (% of company you own)
  2. Subsequent dilution (factor of both future funding amounts and the structure of future deals – do new investors have a preference return ranking ahead of yours?)
  3. Time to Exit
  4. Exit Value

Most founders / investors spend lots of time on item 1 – and almost no time considering 2, 3 or 4.

In determining your financial return the % you have of the company at EXIT is much more important than the % you have at round one. Yet so many investors spend enormous amounts of time focused of getting that initial valuation ‘right’, and no time considering the company’s future funding needs, their ability to contribute to those needs and their resulting dilution.

There is no point in having what looks like a large % at exit, if the other investors have a preference over you. I have seen an exit at $475 million – with the angels getting zero as a result of the preferences.

Don’t let those unicorn valuations fool you. The reality is in the detail of the last finding round terms (which will not be disclosed). Frankly you can claim whatever stupidly high valuation you want – if I have a 3x preference that I will take off the exit table before anyone else gets a penny.