??French startups: Do you know how to value your company when raising funds in the United States?

The valuation of a startup is a crucial step in its fundraising process. For French startups looking to raise funds in the U.S., the task can seem difficult. However, with a good understanding of valuation principles and a clear strategy, it is manageable.

#1 Understand the concept of valuation:

The valuation of a startup is not based on traditional financial ratios, which are of limited relevance to an early-stage company. Instead, valuation focuses on elements such as equity cost: it can be calculated using the capital asset pricing model (CAPM). This method is based on the idea that investors are remunerated by the time value of money or the risk.

Clearly, a startup's valuation is an estimate of its market value at a given point in time. It reflects how much founders and investors value the company, taking into account the market forces of the industry and sector to which the company belongs.

Pre-money valuation is the value of a company before it receives outside investment or financing. It is often used in negotiations between the entrepreneur and potential investors. Pre-money valuation is determined by the entrepreneur and potential investors, and is based on factors such as market conditions, the nature of the business, and future growth prospects.

Post-money valuation is the value of a company after it has received investment or financing. It is calculated by adding the amount of the investment to the pre-money valuation.

#2 Valuation methods:

Discounted Cash Flows (DCF) method: This method is based on the idea that the value of a company is equal to the sum of the future cash flows it will generate, updated to its present value. For example, if a start-up expects to generate 1 million euros in free cash flow every year for the next five years, and the update rate is 10%, the company's value would be 3.79 million euros. However, this method can be difficult to apply for a startup, as it requires precise financial forecasts, which can be a challenge for a company in its early stage, they often underestimate expenses and working capital needs.

Scorecard (or Dashboard) method: More commonly used by business angels for early-stage, pre-seed startups, the "Scorecard" method compares the target startup with other comparable companies (at the same stage of maturity, geography, business model, etc.), then adjusts the valuation according to a number of factors. So, the first step in scorecard valuation is to find the average pre-revenue investment value in the target startup's region and industry. You can use a pre-money valuation calculator. Then you need to determine what factors in your company's success need to be taken into account. The main criteria are, in order:

• Board of directors, entrepreneur, management team - 25
• Size of opportunity - 20
• Technology and product - 18
• Marketing and sales - 15
• Need for additional financing - 10
• Other - 10% of total

These percentages can be adjusted according to the investor's preferences, but the important thing is the startup's potential. Once these factors have been identified and balanced, you can move on to evaluating your startup. If your startup is above the norm, the score will exceed 100%; if it's below, it will be below 100%. Let's say your company scores 140%, then your multiplier will be 1.4.

Comparable valuation: This method compares the startup with other similar companies to determine its market value. The first step consists of selecting a sample of comparable businesses (public or private) with similar characteristics to the business being valued. These characteristics may be:

• Geographical area
• Size and maturity
• Business sector
• Products and servicesompetitive position
• Growth rate
• Financial structure
• Accounting methods (e.g. International Financial Reporting Standards)

Once the sample has been established, we then need to identify a number of financial indicators, known as multiples, which will allow a comparison between the company to be valued and the established sample. It can be an indicator before (turnover…) or after financial expenses (net income, cash flow…).

The venture capital method: This method involves estimating your startup's future exit price, the venture capitalist's desired return on investment (ROI) and the dilution of future investment rounds to calculate the current valuation.

#3 The risks of overvaluation:

When a startup's valuation exceeds its actual worth, it can lead to complications during future funding rounds. This situation often arises when a startup fails to meet its set objectives, leading to a devaluation in subsequent funding rounds, a phenomenon known as a "down round."

A "down round" can have significant implications for a startup. It can dilute the founders' stake and negatively impact the company's reputation, thereby discouraging potential investors. For instance, if a startup initially valued at $10 million fails to meet its growth targets and is later valued at $8 million in a subsequent funding round, it's considered a down round. This can lead to a decrease in the founders' ownership percentage, especially if they don't have anti-dilution provisions in place.

Furthermore, certain redemption clauses, also known as "Ratchet Clauses," can significantly impact capital distribution during these down rounds. These clauses include the "full ratchet," "narrow-based weighted average," and "broad-based weighted average."

For example, a "full ratchet" anti-dilution provision protects investors by ensuring that their percentage ownership remains constant, irrespective of future funding rounds. If a company issues new shares at a price lower than what the investor initially paid, the full ratchet provision adjusts the investor's purchase price to the new lower price, thereby increasing their percentage ownership.

On the other hand, "narrow-based weighted average" and "broad-based weighted average" are less severe forms of anti-dilution provisions. They adjust the investor's purchase price based on the extent of dilution and the number of shares involved in the dilution, with the broad-based method considering a larger number of shares in its calculation than the narrow-based method.

Another critical aspect to consider is the "liquidation preference" clause. This clause ensures that investors receive a return on their investment before the remaining funds are distributed. While this may seem reassuring for investors, it can pose a significant risk for founders and employees. For instance, if a company is sold and the sale proceeds are less than the amount invested, this clause ensures that investors will receive their investment first, which could leave founders and employees with little or nothing in the worst case.

A realistic valuation and careful negotiation of the terms of your funding round can greatly contribute to the long-term success of your start-up. To learn more about startup valuation, you can take a look at our recent webinar led by Jade Ruscev, Esq. and Olivier Njamfa : https://www.dhirubhai.net/events/naviguerleslev-esdefondsauxetat7065230736517148672/theater/

Any questions? Feel free to ask them in the comments or in private. :)

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