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Mark-to-market to arrive at a realistic valuation and improve your fundraising odds

A guide for founders who have less than 12 months of runway

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Falling red dominoes stopped by a small block to allow green dominoes to stay upright; mark to market startup valuations
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Ben Boissevain

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Ben Boissevain is the founder of Ascento Capital, a boutique investment bank that provides advisory services for M&A, capital raises and valuations to technology companies in the U.S. and internationally.

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Valuations in 2022 have been falling like a rock as the war in Ukraine rages, inflation skyrockets and the Fed tightens the screws.

Fintech firm, Klarna, whose valuation plummeted 85% to just $6.7 billion from $45.6 billion a year ago, is an extreme example of this. Klarna’s woes are also related to the “buy now, pay later” subsector falling out of favor, but it’s not alone. Almost all tech companies are seeing their valuations decline — the Nasdaq is now more than 31% below its all-time high on November 19, 2021.

The public market’s pessimism is bleeding into the private market as well. Even early-stage deals are being affected; many new seed and Series A deals now valuing startups at about 50% less than last year.

Why create a realistic valuation?

Amid a global meltdown, it is critical for a startup’s management to realistically assess the company’s valuation to increase its chances of securing the next round of capital or an exit via M&A. Tech companies that continue to hold on to their unrealistic 2021 valuations will find it very challenging to finance or sell the company and may risk running out of runway.

Selling your company below the last round’s valuation can be painful, but closing it down, firing all your employees and liquidating the assets will be excruciating at the least.

Companies with decent runway — say, over 12 months — don’t need to change their valuations unless an M&A event occurs. But companies who don’t have as much cash on hand may find it helpful to reassess their valuations so they can consider more realistic financing options.

This is an opportune time to mark down your valuation, as investors are already seeing their portfolios lose money. In fact, venture firms in the U.S. are required to review valuations every quarter in a process called “mark-to-market.”

Usually, valuations are based on the most recent funding round unless there is a severe impairment, such as loss of a key geographical market. But when the macroeconomic environment changes drastically, like it has now, venture firms need to mark down their assets more aggressively.

When it comes to M&A processes, it can be helpful to have realistic expectations of your company’s value and focus on how your company will fit strategically with the acquirer. The higher you expect your startup’s valuation to be, the lower the probability of the deal going through.

How to mark-to-market

Mark-to-market means calculating your valuation based on comparable public companies’ stock prices today, recent private company funding rounds and recent M&A deals in your subsector.

Comparable companies are companies that are similar in terms of the subsector, size and growth. Later-stage startups should be compared to public companies trading in the stock market.

For early-stage companies, it is helpful to review the valuations of recent fundings of competitors on PitchBook, Crunchbase and Craft. Exactly which comparable companies are selected and why is always a key negotiating point in the valuation discussions.

Precedent transactions are recent M&A deals involving similar companies. This is challenging in 2022, since the deals that happened in 2021 are largely irrelevant given the high valuations prevalent at the time. It would be prudent to choose transactions that were announced in 2022.

Once you have the revenue multiples of the comparable companies and M&A deals, throw out the highest and the lowest multiples. Then take the mean multiple and multiply it by the last 12 months’ revenue of your company. This is your company’s mark-to-market valuation.

Exceptions to mark-to-market

One of the smartest CEOs I’ve had the pleasure of representing sold his company for 14x revenue right after the dot.com bust. This was in the middle of the “nuclear winter,” as it was called, based on a single precedent transaction with a 14x revenue multiple that I found in my research.

I had explained to the CEO that in the traditional method, one would take the average of the comparable companies and the precedent transactions, but he wanted to put the 14x multiple on the table.

This CEO would spend an hour a week reviewing comparable public companies, recent private financings and M&A transactions in his specific subsector. He knew that the buyer needed to acquire his company desperately to fill a major hole in its product line, and his logic was that the 14x number would allow the acquirer’s board to hang their hat on a recent transaction for cover.

The lesson here is that valuations are ultimately determined by supply and demand in the M&A market.

Another exception to the traditional fundraising route are extension rounds, where a company asks its current investors to write a check in a bridge round at the previous round’s price and terms. It is often easier to keep the valuation the same as the last round and simply consider the investment an extension of the last round.

Finally, acquirers have their own internal valuation models that sellers never see. For example, an acquirer may ask their global sales team how many of the target’s products they can sell over the next three years, multiply that number by the price, cut that number in half to be conservative and cut it again in half to arrive at a valuation for the target.

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