Flynn's Harp: Good valuations key to start-up funding (1/26/11)

Bill Payne is convinced that an honest understanding of valuations on the part of both angel investors and capital-seeking entrepreneurs is important to the deal-flow that’s vital to a healthy environment for emerging businesses, perhaps now more than ever.

One of the reasons understanding current realities is important for both angels and entrepreneurs is that the valuation process, which helps determine how much of a company the angels are buying for their money, is leaving entrepreneurs having to settle for less.

“It is simply a sign of the times,” said Payne, often referred to as the dean of angel investors. “Entrepreneurs with quality deals are forced to offer higher equity stakes to raise money from reluctant angels during this recession.”

Thus Payne spends a lot of time advising angel groups not only how to be successful investors but also in educating both angels and entrepreneurs to the investment process and those realities.

He’ll be doing one such seminar in Seattle next week, sponsored by the Northwest Energy Angels, which since its founding in 2006 has attracted more than four dozen members who have invested about $3.5 million in an array of clean-tech businesses.

Payne, who winters in the Las Vegas area and summers in Montana’s Flathead Country, says “savvy entrepreneurs and investors are likely to agree upon valuations quickly if they are on the same page. That means less acrimony in negotiations and allows getting on with the much more important business of executing on the plan.”

The two-part workshop in Seattle is expected to attract angel investors from around the Northwest, as well as entrepreneurs interested in getting a better sense of the current angel-investor environment. (The link is www.nwenergyangels.com/workshop.)

Payne, who does similar sessions around the country, often under the auspices of the entrepreneur-focused Kauffman Foundation, will provide an overview of due diligence and, in the second session, help educate angels and entrepreneurs on ways to value pre-revenue companies.

One thing on which Payne seeks to guide both sides is understanding the importance of an “exit strategy” that will bring the angels a satisfactory return on their investment.

“We have to make sure there is a reasonable exit strategy,” Payne said in a telephone interview this week. “We run into a lot of naïve entrepreneurs who think angels are going to give them $300,000 to start their company and, in three or four years, pay the money back, We have to make sure the entrepreneur understands that we are investors, not bankers.”

Expanding on his statement that pre-money valuations have declined, he said that an informal survey he did of angel groups around the country in late summer suggested that the average valuation of pre-revenue companies was between $1.5 million and $1.7 million. “It was a little higher in Boston, Seattle and Silicon Valley and a bit lower in New York and, for whatever reason, Southern California.”

Payne noted his own experience of investing in about 50 deals since 1980 found him investing only once in a seed or start-up deal with pre-money valuation of less than $1 million.

“But the last deal I invested in was a $300,000 investment round at a pre-money valuation of $400,000,” he said. “And I’ve heard of many other seed and start-up deals closing at valuations of less than $1 million.