Updated: Jun 24, 2022
This post is not specifically about how to create a valuation of your company when you raise money. It's about how many start ups mis-interpret the signal they are receiving. In this case mis-interpreting receiving EU funding and / or great PR in their local country as a metric for US market valuations.
One of the really hard things to figure out for an entrepreneur is "How much is my company worth?". This is especially important when you are raising money from investors to determine what percentage of the company you will give away. While there are many resources online that explain methods such as Discounted Cash Flow (DCF), Berkus Method, Comps based, etc.... it's still can be a daunting task because you are not really sure where in the life cycle your company fits, what are realistic assumptions to make, etc..
For starters I should clarify that my proxies in judging valuations in the ex-Yu region are based on my experiences with (a) predominantly US East Coast deal flow I see through my angel network, (b) early stage companies in the US that I have either invested in or coached/advised, and (c) my own company sales process and acquisitions we made or looked at during my time at OPRX.
In the past year I have talked to at least 50 plus startups in Croatia, Serbia and Slovenia, and there are two things i noticed:
Companies in the concept to early commercialization stage tend to have valuations that have significantly higher multiples then US companies at the same stage.
I will list a few examples here, but only with directional numbers for confidentiality reasons. Two companies I came across late in 2021 with annual revenues in the US$200,000 to US$300,000 range valued themselves in the $14 - 15 million range. On average that is an approximate revenue multiple of 58 times. While innovators, neither one of these companies is a software or hardware based tech company.
Companies in early stage of commercialization, that have significantly more traction in the market have much more realistic valuations.
Two examples here would be two SaaS companies with over US$800,000 in sales valuing themselves at $8 - $10 million, and another at US$7 million.
These discrepancies do not seem to make sense, so why is that? There are probably multiple reasons for this, and I will touch on two of them:
The existence of EU Funds is very important because it tends to be the first source of capital for many companies, and most importantly it's non-dilutable funding, meaning you get the money for "free". You don't have to give up a part of your company and you don't have to pay it back. Everyone who can should take advantage of this. While the US has forms of non-dilutable funding, such as grants, it's not nearly as easy to access.
Where I see the "trap" with EU funding is that for many startups it creates the wrong perception that EU funding is the same type of market validation as getting funding from an investor. It is NOT the same. There are two important things to take into account:
The mandate for the EU funds is to stimulate innovation with the hope that it will stimulate the economy through higher employment, productivity, etc. The mandate of an investor is to maximize their return on the investments. The salaries and job security of those who decides about the allocation of these EU funds is not directly correlated to the performance of the companies receiving the EU Funds, unlike that of a professional investor.
The EU invests taxpayer money, while the investor invests either their personal capital or invest their clients' capital where the ROI for the client has a direct impact on their income. In other words their incentives are aligned and they will act in the same way.
The main message to start ups is use as much non-dilutable funding as you get, but don't perceive it as a market place validation. Your investability validation will come from the private markets, and your business validation will come from your customers. Make sure to take this into consideration when setting your valuations. One could even argue that if you received significant non-dilutable funding, it should make it emotionally somewhat easier to stomach a round where you have to give equity away because you got so much for "free" already.
It's also important not to confuse direct EU funding with VC or other type of funds that have EU funds as investors in their portfolio. The rigor of investment professionals evaluating deals will depend on the incentive structure that is in place. The more their compensation is tied into the performance of the fund the more rigorous the due diligence will be and vice versa.
Local Press Coverage
Being able to raise awareness in the marketplace is very important both towards investors and customers. Additionally getting others to talk about you [Public Relations] vs. you talking about yourself [Marketing] is always more cost effective.
Some companies are much better then others in getting press coverage and when you have a lot of people talking about you, you will tend to feel more important. The more important you feel, the more valuable you will think you are. But here is what i would ask everyone to ask themselves. What's harder, to be the talk of the town in Belgrade, Zagreb or Ljubljana, or to be the talk of the town in New York, Shanghai or London?
If a company wants to have US valuations, you need to be the "talk of the town" in New York City. The main message being don't let the local media coverage get in your head. Think about that when you are setting your valuation.
No matter what we think or do, the market forces will teach us lessons we need to learn. The quicker we learn them, and adapt, the faster we will advance.
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