About the Author: Stu Strumwasser is the Founder and Managing Director of Green Circle Capital, a leading boutique investment bank focused on the natural products space. He spent the early part of his career at firms that included Paine Webber (now UBS AG) and Oppenheimer & Co., and has been a licensed investment professional for over twenty years. He was also the founder of a natural beverage company which he ran as CEO for six years. Stu is also an author whose novel, “The Organ Broker,” was named a finalist for the Hammet Prize. Securities transactions are conducted through StillPoint Capital. LLC, Tampa, FL. Member FINRA & SIPC. Stu can be reached at firstname.lastname@example.org and www.greencirclecap.com.
Part I: Evaluating Valuation
As an investment banker in the Consumer space (focused on natural products) who often talks with the CEOs and owners of early-stage and growth-stage companies I am frequently asked, “What’s my valuation?” My short answer is: “Whatever the market will bear.” It rarely satisfies.
The long answer is some version of a conversation that all entrepreneurs, business owners, executives, investment bankers, accountants, corporate and M&A attorneys, investors and others have had countless times—a discussion of the methods and metrics utilized to arrive at valuation for investment transactions involving businesses with limited operating histories and/or at a stage in their development where they have not yet generated consistent positive cash flow. The productivity and tone of those conversations depends on the experience, sophistication, and personality of the participants, but also includes a myriad of other factors such as the temperature of the respective rooms they sit in, the “breaking news” on CNN, the direction of the NYSE that day (or minute), whether Mercury is rising (and/or in retrograde) and possibly the early-morning tweets of our elected officials…. As any forensic accountant will explain, the most important data point in any assessment of the “fair market value” of a private stock is what an objective and unaffiliated party has actually paid for shares. (In the parlance of my Brooklyn neighborhood: “Money talks; bullsh*t walks.”) In the case of a large, publicly-traded company on a major exchange, one might only need to look as far as the closing price on a particular day in history. For a private stock, it is more complicated. If that private stock hasn’t been transacted recently (or ever) it can be far more nuanced. I’ve had these conversations more times than I’ve seen a new plant-based, protein-fortified, organic, meal-replacement bar at Expo West, and they often devolve into unproductive philosophical musings or even awkwardly contentious debates. I am sure that every investment banker who works with early-stage or growth-stage companies has asked themselves, on many occasions, “Do I tell this guy the truth and risk losing the opportunity?…. as well as another twenty minutes of time?…” After all, in the end it isn’t up to us (the intermediary investment banker); it’s what the market will bear. Or bare.
“What’s My Line?” was a panel game show that originally ran on the CBS Television Network from 1950 to 1967. The game required celebrity panelists to question a contestant in order to determine his or her occupation by attempting to learn new information and narrow down the options. “What’s My Valuation?” is vaguely similar. The more early-stage the business, the less the valuation is a function of traditional metrics (such as multiples to EBITDA and/or revenues) or “math,” and the more it becomes a function of artistry. It’s actually one of the reasons I like working with smaller company clients (for us, typically $5MM-$50MM in revenues) as it is more creative, we have a greater opportunity to make an impact, and we can add value for our clients by deftly creating the right environment for a transaction and by generating competition for the asset which we endeavor to sell. Unfortunately it also often sets the stage for those meandering “What’s My Valuation?” debates, so I thought that it might be helpful to some CEOs/CFOs, business owners, investors, and my colleagues, to jot down some of the thoughts I have shared many times on this subject over the years in individual conversations.
When I meet leaders of growing businesses I ask them to, “Tell me about your business.” What I often get in return is a thirty-minute dissertation on their product, often replete with some hyperbole about future (and uncertain) sales opportunities, and very little about what I was actually interested in: the existing distribution, sales velocity (the “mother of all metrics”), gross margins, gross and EBITDA margin goals that are achievable with the evolution of scale, go-to-market strategy, capitalization to date and…. the company’s future financing needs and plans. “Important Paradigm Number One” for founders: If most startups that fail do so because they run out of cash, maybe you should spend even more time focused on understanding and securing the financing you need (and less time dreaming up marketing campaigns that you can’t yet afford). I became a vegetarian when I was fourteen (and I have now turned 39 twelve times, so that was quite a while ago) and I founded a natural soda company in 2005 partly because I genuinely wanted to help save consumers from harmful chemicals contained in traditional CSDs. So I get it if money isn’t your sole priority. However, if it isn’t near the top of the list perhaps you should live on a self-sustaining family farm (albeit an organic one) and not be asking other folks to invest millions of dollars in a for-profit business venture.
Why are so many founders/executives/owners of growing businesses deeply concerned—or even obsessed—over valuation? I don’t know, but it really can be counter-productive. When I raised capital several times I was of course committed to getting a fair market value, but I was never clutching some hypothetical and somewhat-arbitrary figure with cold, dead hands. I made countless mistakes as a founder and operator (for a summary list just take a look at the playbook for Zevia, check out everything that they did correctly in terms of execution, and then just assume that I did the opposite)—but getting stuck on a valuation goal was never one of them. It leads me to Important Paradigm Number Two: No one ever went out of business due to dilution.
Some business owners think, “Well, can’t I just start real high and know that I can always come down in price if necessary?” Um, not necessarily. When you are trying to make a deal with someone who you think is asking for something unreasonable, do you always make a counter-offer and try to work it out? In the case of a prospective investor assessing a potential investment, bear in mind that the biggest factor in his or her decision will often be their evaluation of you, the entrepreneur. Appearing unreasonable or, perhaps, potentially uncompromising or difficult to work with, is not a good way to begin.
Here’s one other thing to consider: If you think that your deal, inclusive of proposed valuation, is “fair,” is that really enough? When you go shopping, whether it be for a car, a skateboard, a stock…. A private stock in an early-stage natural products company…. Do you find yourself looking for a “fair deal” or “the best deal?” It is sometimes lost on Founders and CEOs that the investors they are pitching (sometimes with the help of a firm like mine) see a lot of investment opportunities. In fact, most institutional investors or serious angels look at a few hundred each year. They might make perhaps one or two investments each fiscal quarter, and some even less. So, whether one acknowledges it or not, you are competing with hundreds of other investment opportunities, some of which are surely also attractive. You are soliciting investors who may “pull the trigger” on around one percent of the opportunities they see, so anything that may give them a reason to pass on a deal is actually helpful to them in managing their time and dealflow, and narrowing down their choices. Don’t let getting stuck on an above-market valuation be the reason you miss out on getting the cash you will certainly need to grow a capital-intensive CPG business, or lose a chance to connect with some folks who might have been excellent value-added partners. Closing on a timely financing or acquiring great partners can turn out to be a critical component in your success, and giving up a few extra points in dilution will never be the reason you fail.
In Part II, Strumwasser examines the methodology for actually arriving at fair market value for growth-stage natural products companies using comps and other tools. Check back next week.