Early-stage valuation tips
Vijay Tirathrai of Techstars Dubai shares pointers on how seed-stage companies can improve their chances of attracting funding
Do a quick Google search and you’ll find that there are several methodologies investors apparently use to value a start-up in the pre-revenue phase.
But as UK-based seed fund Seedcamp puts it, “as frustrating as this may be for anyone looking for a definitive answer” to how early-stage investor value a start-up, valuation is not an exact science.
And Vijay Tirathrai, managing director at seed accelerator Techstars Dubai, seems to agree. He believes an investor’s experience plays a crucial part in the successful valuation of a start-up that has yet to post any significant traction.
“A start-up in the seed stage has the highest risk [among the different financing stages] because there are way too many unknowns – for example, it doesn’t have financial data, cash flow, or balance sheet. All you are evaluating is the idea, caliber of the team, addressable market, and how the start-up is trying to take its technology or product to the marketplace,” said Tirathrai, who spoke on the sidelines of the recent STEP Conference in Dubai.
In the absence of any measurable piece of data that can be used to effectively assess a start-up, he said successful valuation primarily rests on the “instinct” of the investor.
“The success rate, to say the least, will come from an investor’s experience in looking at deals on a daily basis, and somehow [having that instinct to know] which is the right team to invest in,” he added.
Valuation vs traction
According to Upcounsel, valuation is important because it determines the equity a founder has to give away in exchange for funding. So the higher your start-up’s valuation, the lesser the shares with which you have to part.
Interestingly, Tirathrai said for early-stage start-ups, however, the focus should be on traction, rather than valuation.
“A lot of start-ups may not even have customers, or are still building on a technology or idea. So we ask them to think about developing an MVP [minimum viable product], pilot projects and use cases, which can help them get potential customers. By doing that, they are also building credibility,” he said.
Without a large customer base on which to assess their business model design, founders can make their start-ups attractive to investors by getting their product up and running as soon as possible and bringing it to market, so they can collect feedback from customers. Initial customer feedback, Tirathrai added, is crucial because it tells a start-up how to innovate and improve its product base.
At the culmination of every pitch comes the biggest question every start-up founder has on his or her mind: How much money to ask?
Tirathrai admits that this can be tricky, as there are several variables to be considered including the industry in which the start-up operates and whether it is building a hardware-type technology or a software.
“But here’s what I would say: when you do your first raise, think [of having] sufficient runway for at least 18 to 24 months because you don’t want to be in a situation where you’re constantly fundraising,” he suggested.
Doing so would also allow a start-up to focus on developing its product, tweaking business development strategies, and building credibility in the market.
To secure an investor’s thumbs-up, Tirathrai advises start-up founders to be considerate about how much money to ask and what they need to achieve within a specific milestone.
“One of the greatest failures of a start-up is not being thoughtful of their cash flow plan when they fundraise. They have to be very honest with investors, but at the same time, they must not ask too much money,” he said.
Asking for a significantly high amount of cash leads to two issues, which might not bode well for the founders. First, it could disappoint investors because the start-up was unable to fulfill its goals, and second, founders could give away too much equity in the early phase of the company.
“This means that as you build your company and you give equity away in subsequent fundraises, it becomes less of an incentive for you as a founder to hang onto the company. So you have to strike the balance between giving some equity away and getting enough runway to build a product that you can bring to the market,” Tirathrai said.
The Techstars Dubai MD also underscored the importance of bootstrapping in the early days.
“There is no shortcut. Start-ups have to be frugal and should not spend extravagantly on anything. Having the right mindset is key,” he concluded.
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