When economic uncertainty or internal risks challenge your business, your major priorities will be to maintain your operations and preserve business value. For businesses that are actively fundraising or that have raised funds already, your investors will be equally invested in your company’s ongoing ability to deliver on its key promises.
While some factors may be outside of your control, such as a recession, there are still actions that you can take today to maintain investor confidence and mitigate additional risk for the future.
How is a business valued?
“Valuation is very much an art and not science,” states Paro fractional CFO services provider Scott Z. “And just like any art, whether you’re thinking about music or painting or whatever it may be, you have to practice and you have to learn different techniques. Valuation is exactly the same.”
There are several formal methods used to assign an economic value to a business, but they often begin with reviewing a company’s financial statements. Data points for the book value, revenue stream details, cash flow management and key KPIs are just some of the information used to value a company.
But financial statements alone do not tell the whole story. Competitor analysis and precedent transactions (i.e., how similar companies have been valued in the past), the broader economic climate and the strength of the team will also weigh heavily in a business valuation and in investment decisions.
“There’s many variables that impact valuation, and it’s usually multiple data points that investors rely on to base their valuation thesis. I think having a good understanding for each of those data points allows you to have a more articulate conversation with potential buyers. Your financial advisor can help you understand which variables are most relevant to your business,” says Scott.
How do investors value your business at different funding rounds?
For businesses that are pre-revenue, 90 percent of the business’s value will be the expertise and experience of the owner and the team, as well as confidence in the ability to execute the business plan. For more mature companies, investors have a track record by which they can judge the company.
Scott states, “As you’re moving through angel, seed, series A to B, and so forth, information about your ability to execute and historical financial metrics are going to increasingly inform valuation.” Higher visibility of your KPIs and financial metrics to your investors will be increasingly important as economic uncertainty looms.
Wait out the storm or forge ahead in times of uncertainty?
The conversation to seek funding will change depending on the reason for a potential change in business value. Investors will react differently to external factors that affect the entire market versus factors that affect your business specifically.
- External factors, such as broad economic inflation or a growing climate of risk aversion are beyond a specific company’s control. How the company is responding to them will play a role in investment decisions.
- Unique factors, such as missing a milestone or a new competitor, will be intensely examined and play a significant role in the valuation of a company.
Whether a company decides to pursue outside funding in times of uncertainty will depend on each unique situation. Owners should expect more difficulty in getting investors and understand that higher interest rates or giving up a greater equity stake will likely be necessary. While it’s ideal to avoid a down round, some investors may see market uncertainty as a time to gain more market share or increase runway for larger goals.
What is a down round and how does it affect investors?
“A down round is when you raise capital with a lower valuation than the previous round’s valuation. When you’re raising money in a down round, what you’re doing is you’re paying more for whatever capital you’re getting,” says Scott.
Some investors may shy away from investing in a down round, but others will take time to review whether it presents them with an opportunity to earn a higher return than they would have received if they invested earlier.
Potential and current investors will both want and expect proactive communication regarding the business valuation. The management team must be transparent in explaining the down round valuation and detail which internal or external drivers are impacting business value and how they’re responding.
How to preserve business value and avoid a potential down round
Avoiding a down round is preferred, but it’s not always possible during expansive growth. Scott advises that when companies prepare for a capital raise, they should seek to raise more funds than they anticipate needing. If 18 months of capital are needed, raising funds to cover 24 months could provide enough cushion to avoid seeking funds during times of lower investor confidence.
Manage cash effectively and maintain your runway
Preserve business value by being able to maintain your operations effectively. That means having enough cash and runway at all times to keep the business running. In the event that you must build a leaner operation, tapping into freelance talent can help provide continuity for your business while removing the cost of full-time hires as capacity or demand changes.
Increase investor confidence with frequent communication
“Communication is critical,” says Scott. “You need to maintain those relationships and make sure that you’re communicating effectively and timely.” He advises that businesses facing difficult issues may even look to their investors for advice or consulting.
But most importantly, report to your investors as frequently as you did before your circumstances changed. He states, “When you’re not providing feedback quickly, or you’re not doing your managerial reporting as fast as you had been previously, if there’s news specific to your company and you’re not communicating about it, then those relationships are going to start to erode.”
Forecast risks before they happen
Managers need to ensure that they have accurate and timely financial and operational data and are vigilant about keeping abreast of changes in their marketplace.
“The best managers are really good at forecasting and seeing into the crystal ball. [They] set things up in a way that when the unexpected happens, that they’re prepared for it—[and] better prepared for it than their competitor,” says Scott.
Understand your business, track your businesses and be aware of what’s happening in the market. Being able to do this requires good advice, as well as experience, according to Scott. And for business owners who have not been down this road before, outsourcing an expert will bring in industry experience and financial forecasting knowledge necessary to help you protect your business value.
When does it make sense to bring in external experts?
Bringing in fractional strategic and accounting expertise at critical times can be a wise use of resources and a way to help you preserve business value. Employing flexible strategic advisory can increase available data points and enable you to make better decisions for the future.