For better or for worse, most deals in business do not follow the same procedure that ideas pitched on Shark tank follow. Outside of “The Tank”, there are numerous different ways of coming up with the valuation for a business. While each methodology involves chance and projections, most are set apart from one another by the values placed on different deal inputs. The excellent book called Winning Angels by David Amis and Howard Stevenson breaks down twelve of these various methods that different angel investors use to value a business. For our purposes, however, we will only look at three valuation methods in this article: the Multiplier Method, Rule of Thirds, and Virtual CEO.
The Multiplier Method
Although based on assumptions, this method of valuation compares the worth of a proposed idea with the worth of established competition in the industry. To decide on a valuation, you simply take a projected metric and multiply it by the revenue a similar metric generates for the competition. For example, let’s assume that we want to start a gym. Our goal is to have 1,000 memberships by the end of year two, and the industry average annual revenue on a membership is $360. To find our valuation we will multiply the 1,000 memberships by the membership fee of $360 to get a $360,000 company valuation. As David Amis and Howard Stevenson warn in their book, however, the tricky part about this valuation method is deciding on the right metric to use, since everything is merely projected.
Rule of Thirds
It’s one of the most simplistic methodologies for business valuation, and I’d guess that you might have already figured it out just by reading the name. A business is divided into equity positions of thirds with one third going toward the person responsible for the idea (founders), one third for management, and a final third to financial backers. And although the quickest route may not always be best, there is some value in finishing the valuation process quickly without haggling. After all, who wouldn’t agree that the Rule of Thirds is a fair deal?
This valuation method puts a different twist on the subject as it doesn’t involve the angel investor giving money to anyone. Instead of financial capital, the investor is expected to give significant personal and social capital to the new venture in exchange for an equity position in the company. Although details surrounding what percentage of ownership the angel will receive are not calculated with this method, it definitely changes things up by bringing in a different kind of value. Typically, however, the equity stake that a Virtual CEO will receive is smaller than that of a financial backer – although a monthly fee or salary may additionally be negotiated, depending on the level of assistance provided.
David Amis-Howard Stevenson (2001). Winning angels: the seven fundamentals of early-stage investing. Pearson Education.