Imprecise Precision and Company Valuation

Posted on November 6, 2007. Filed under: Company Financing, Other |

My Eagles aren’t so good this year, and I’m the kind of sports fan who ties my emotions pretty tightly to the fate of my team (at least until the last whistle blows and I go back to being my kids’ dad).  I don’t get loud or violent when my team stinks, but I do get negative, and when I’m feeling a little less than sunny, I can spot flaws and find faults in just about anything.  So, while the Eagles were putting the nation to sleep last night against the Cowboys, I had plenty of opportunity to give some thought to something which I realized has made me uneasy me for some time now.

Why do NFL referees make such a big show out of bringing the chains on the field to precisely measure whether a team has made a first down when they’re using the highly imprecise spot of the ball to make this determination?  Is this a P.T. Barnum sucker kind of show?  You have a head linesman on the sideline sometimes as far away as the entire width of the field (or more if he’s behind the play) who comes running in from the sidelines at the end of a play to dictate where the ball was down and place the ball for the next play.  There is no way he gets the spot exactly right.  In general, I’m OK with this.  Human error is part of the game.  What bothers me is them bringing the chains on the field to check to see whether the highly imprecise spot of the ball resulted in the nose of the ball precisely breaking the plane of the first down marker.  Whether or not my team gets the first down may have a precise impact on the outcome of the game, and yet this is often based on a highly imprecise spot of the ball.  Short term imprecision may play a part in producing a highly precise result in the long run.

I’m finding that pre-money valuations from potential capital investors are starting to engender the same kind of emotions in me in that a very imprecise pre-money valuation may ultimately result in a very precise result to my family in the long run.  Ask the VC provides a good and simple explanation of how VC’s determine pre-money valuations here.  As above, in general, I’m fine with the way this process works.  For relatively early stage investments, pre-money valuation is simply an entry into a formula that spits out share price to determine equity ownership percentages relative to the amount of the investment.  In many cases the entrepreneur and the investor can even start at the desired result and work backwards together to produce the pre-money valuation.  Clearly this isn’t a precise science.  What is a company worth when it has some product, little or no revenue, and a defined but not yet proven market?  If a knowledgeable entrepreneur has one capital investor with whom they really want to work, and the entrepreneur and the investor can both amicably agree to a deal which results in an investment amount and an equity share which they both believe is reasonable, then as far as I’m concerned this was a good deal for both parties — a classic win-win.

The difficultly starts to set in though when the entrepreneur has multiple possible sources for funding and all of them have different opinions about how the company should approach the goal of dominating the market.  Different approaches may produce different opinions about a company’s pre-money valuation, require different investment amounts, and result in different ultimate equity shares.  Take for example a company who may be talking to a “classic” venture capital firm, a “classic” private equity firm, and a public company interested in making a strategic investment.  All three by their very nature have different investment philosophies and different goals for their investments.  They may also have very different opinions about the value of the entrepreneur’s “product” in its relation to the market which will produce different company valuations.  Again, taken independently, each deal may be “fair” as a stand alone deal, and I suspect that just about every company has faced a “fork in the road” at one time or another and had to choose their direction.  Will option A which gives me less equity result in a more valuable company meaning my smaller equity percentage is actually worth more?  I’m learning quickly that this is the kind of stuff which separates the winners from everyone else.  In my next post I’ll discuss our current personal fork in the road and the options facing us.

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  • About

    Mark Waterstraat

    VP Sales

    Benaissance

    www.benaissance.com

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