Last week I gave some background on 409A valuations: what they are and how to correctly value options. This week I focus on equity valuations.
What is an Equity Valuation?
Equity value is the total value of a company available to owners and/or shareholders. It includes the enterprise value, cash, cash equivalents, short-term investments, and long-term investments.
The equity value also accounts for all ownership interest such as unexercised stock options.
More to the point: an equity valuation is what an investor agrees to based on what s/he is willing to pay.
You can calculate your equity value in one of two ways:
- Intrinsic Method Value – This method considers the underlying perception of the value of a company. To calculate intrinsic value, you’ll need to take into consideration all aspects of your business.
- Fair Market Value (FMV) – This is an estimate of the market value of a business. In other words, it’s the amount that a buyer would be willing to pay in the market-place for your business.
As you can see, the line between intrinsic value and FMV can be blurry and is somewhat an issue of semantics. In actuality, these values will often be the same.
To add even more complexity to this issue, there is also the difference of pre-money and post-money valuation.
- Pre-money valuation is the valuation of a company prior to any investment or financing.
- Post-money valuation is the company value after an investment has been made. Essentially, it’s the pre-money valuation plus the amount of new equity.
Factors that Influence the Strength of Your Equity Valuation
Certain sectors are hot at different times and this makes the valuation of different types of companies very high. A hot sector equals strong valuations. Years ago, cleantech companies were hot. In recent years, gaming and mobility have been. Today, edtech and fintech are hot.
Another factor is the company makeup. Companies led by folks with a proven track record are more likely to get a good valuation. Likewise, your valuation will be high if your company has a great team or the perceived potential for large revenue opportunity.
In future posts, I’ll give you some tips for determining your company’s valuation.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, an outsourced financial services firm that provides early-stage companies with accounting, finance, tax, valuation, and corporate governance services and support. He’s a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.
