Dirk Huelsermann is the founder and President of OVAB Europe. I have never met Dirk, but I am told that I would like him. I already do, just from our text-based, time zone-shifted, trans-oceanic Twitter ties. One of the nice things about Twitter is that you can find and follow people with whom you have common interests and gather new perspectives. In this case, we share a passion for DOOH, as well as for the trends and issues in the venture and financial world. Dirk serves as a wonderful curator of the sources he reads daily, and his tweets lead me to many interesting insights.
The short, cynical answers to Dirk’s question might be “a lot less than what the owners think” or “only what someone will pay for it”. A more thoughtful answer would start with an assessment of the space, the market and the purpose of the valuation. There is precious little generally available information related to digital signage software company valuations, even though there have been a few transactions and a number of companies openly on the market for some time. The reason for this dearth of information is that with one notable exception, all of the pure software companies are privately held. As such, most of the sales that have occurred have been private, and terms of public company acquisitions have not been detailed. We’ll return to the notable exception in a separate post. But first, an examination of the factors involved in valuing a privately held company in a fragmented space. In this post, we will focus on the early stage process. In subsequent posts, later stage valuation and public valuation will be examined.
It makes sense that valuations are lowest at the startup phase, and ramp higher as a defensible market position is defined, again when rapid growth and profitability are achieved, and then again as financial and market share milestones are achieved.
As a company progresses through these stages, valuation becomes an easier task. In fact, the enterprise value of the company increases as it becomes easier to evaluate; more sophisticated and larger investors become interested; and the path to a liquidity event becomes clearer.
To the extent that the graph is in any way related to reality, then the takeaway is that the wide majority of players in the field have both low valuations and limited access to capital. There are few institutional investors left with a taste for startups in a crowded field, preferring instead to invest later at higher valuations when the winners begin to emerge. The blood-letting among those who tried to pick winners 3 to 7 years ago is an ongoing case study in the risk of early stage investing.
Friends, family and angels are the go-to investors for startups, and those investors have little to go on beyond an understanding of the business plan, belief and/or trust in the management team, and their own instincts. Smart startup investors focus less on the current value of the enterprise than its relationship to their ownership position and the path to the next rounds of capital. They know (or should know) that angel rounds are rarely, if ever, sufficient to get a company to the next stages. A seed round may provide enough capital to get through six months and provide the investor with a fairly large stake. The next round generally involves a larger capital raise at valuations and share prices that must reflect the progress of the company and properly manage the demand curve for the company’s equity so that enough is raised from known investors to take it to the next stage (Positioned). Failures in calculating how much is needed, in raising enough, or in getting to that stage soon enough may lead to the dreaded “down round”, in which share prices must be discounted to attract additional capital.
The reality of early stage investing is that investors must ponder dilution in both an “up” and a “down” scenario. If initial valuation was too rich and more capital is required before key milestones are achieved, early investors must either re-invest pro rata in order to maintain their ownership positions, or stand by as others dilute them and establish ownership at a lower basis. If the company was able to hit positive milestones before new capital is required, then the valuation (and share prices) may well go up. Again, early investors must either pony up additional capital or be diluted by new investors. In some cases, a new round may introduce new classes of stock, liquidation preferences and/or warrants, all of which have negative impact on the ownership position of early investors who stand pat, although not necessarily on the value of their investment. Making that first “pass or play” call is seldom easy for the early investors, regardless of whether prices have gone up, down or remained stable, as there may not be enough information to assess risk accurately.
Valuation becomes more tactical in subsequent rounds and stages, when there is more data to consider and key questions have more concrete answers. Did the company meet key product and sales goals? Has the company established a differentiated position? Were they right about the market size, sales cycle and competition? Do they have the right team? What else is happening in the sector? How much tweaking does the business plan require now that it is being executed? In an upcoming post, we’ll look at factors that drive valuation as a company progresses past the startup phase, and also examine public valuations.
What is your experience or perspective on valuing a digital signage software company? Chime in with a comment.