Just 15 months into the relatively ‘uncharted territory’ of Sports Industry, it seems like I have been thrown into a stormy blizzard of sorts (for good). Eversince we started to grow with our digital business initiatives, I was being generously advised by ‘experts’ on way forward for us. While it’s been great, being part of the heady mix of Sports & Digital world, I have been learning along the way. We have had some interesting experiences all along.
Deciding how to value pre-revenue companies is hard. Deciding how much a start-up should be worth is like deciding how much a one-of-a-kind painting should be worth: there are guidelines to move you in the right direction, but in the end you're basically making an educated guess. And if it is about a new phenomenon called ‘Sports’, it certainly isn’t a cakewalk. What's worse, you don't truly know if your guess was good until long after you've locked the deal.
Although I am a novice in the domain of investments where instincts can defy logics, I have been researching and hereby share my views on based on a few thought experiments& insights. I feel that we can’t be horribly wrong if we have based our valuation decision on the following.
Consideration #1: Founding Team
- If the founders are your neighbours or relatives who don't know anything about technology or shopping, then 10% might be worth a few hundred or a few thousand dollars (if you happen to be a generous gambler).
- If the founders are great engineers and salespeople who have proved their mettle earlier, then 10% might be worth tens or thousands of dollars. Maybe even a million dollars.
- If the founders are Jeff Bezos, Larry Page, and Jeff Dean, then 10% might be worth tens or even hundreds of millions of dollars.
Consideration #2: Growth and Engagement
The team has been busy and launched the mobile app 6 months ago. Based on your research of similar apps, you think a typical user's lifetime value (LTV) will be about $2.
- If the app has 100k users and the user base is growing more that 15% per month, then 10% might be worth $500k.
- If the app has 100k users and the user base is growing 30% per month, then 10% might be worth $1.25m.
- If the app has 100k users and the user base is shrinking 10% per month, then 10% might be worth $200k. There's still potential value in the company if they can figure out how to improve their app and get the user base to grow, but a shrinking user base is scary signal.
Consideration #3: Traction and Expected Near-Term Revenues
- If the company has a few experimental clients who are nowhere near becoming paying customers, then 10% might be worth a few hundred thousands dollars (mainly because a finished product with potential is still worth something).
- If there are 200000 users of the product, the plan is to charge each of them â‚¹10 per month, and you believe (through surveying a few pilot customers) that about half of 25000 will become paying users, then you might value 10% at something like $500k or $1m.
Consideration #4: Market Size
You've analyzed the market for the app -- the one where each new user is worth â‚¹10 in revenue -- and have come up with a realistic estimate of the max number of consumers the app can expect to acquire.
- If there are 500k potential users, 10% of the company might be worth $50k.
- If there are 10m potential users, 10% of the company might be worth $1m.
- If there are 500m potential users and you think the app has a good chance of acquiring most of those users, then the value of a 10% stake is only limited by your optimism and your bank balance.
Consideration #5: Competition
You've taken a good look at its founding team, its 100k app downloads so far, and its market potential, and now you turn your focus to the competitive landscape.
- If the app has no competitors, you might value a 10% stake at $750k.
- If it has one competitor which has less than 10k users, you might value a 10% stake at $500k.
These thoughts are meant to show how different attributes contribute to the value of a company. (The numbers are meant to be illustrative only.)
In addition to these factors, there are other things at play when determining valuations:
- Market forces. It doesn't matter if you think a company is worth $5m if other investors all think it's worth $7m. If the market says it's $7m, then it's $7m.
- Quality of other investors. If a startup has very notable investors, it might be able to command a small premium.
- Comparables. If most comparable startups are valued within a certain price range, then that price range provides an anchoring point.
The way that I am approaching valuations is to first look at comparable companies to get a baseline value for a company. I then try to make reasonable adjustments for exceptionally good founding teams, markets, products, or growth/usage metrics. In the end, one can come up with an estimate.
On final note, valuations do matter, but exact valuations do not. As per some credible data, the average return of an angel investment is 2.6x over 3.5 years, and it's okay if your valuation estimates are off by 5-10% once in a while. For Investors, the quality of companies that they invest should become more important than the ability to calculate their valuations to the nearest dollar.
Speaking for the entrepreneurial ventures in Sports, Investors in these uncertain economic times are looking for stability and predictability when they decide to invest extra dollars. While it seems like a slam dunk of an investment theme for Sports in India over the last 2-3 years, many rational investors would argue this as compelling value propositions as recent, young and vibrant opportunities. And I agree that these businesses are not risk-free and in many ways can be more risky than traditional corporations. And that is the reason why we face difficulties in raising resources unlike other new age businesses. But as many times in the GAME, when a team has virtually no chance of winning, it becomes a great indicator of who the best players are. Who's still launching himself out of the box, scrapping his way to first heroic act? Who's still diving for balls? Who's still getting dirty?
Those are the committed players, who realize that consistency over time equals credibility. The ones who know that to be successful, you have to give your all, whether you're winning or losing. And that’s the key to success against the odds.