The Significance of Valuation for Start-up Companies

Johnny Yu, Managing Partner, Mosaic Venture Lab

Johnny Yu, Managing Partner, Mosaic Venture Lab

The author has served in the pharmaceutical industry and financial holding companies, holding important positions such as Regional BD&L, Head of M&A, and PE Fund Manager. Currently, serving as the Managing Director of Mosaic Venture Lab.

One day, after a formal training session for university start-up teams, I followed the usual practice of leaving 10 minutes for students to ask questions. Whether it's about personal career planning or important considerations when establishing a start-up company, I always maintain an attitude of sharing knowledge without reservation. After all, they are the future hope of Taiwan, and I look forward to gaining some out-of-the-box ideas from their questions. These ideas can inspire me in designing counseling courses specifically tailored for start-up teams in the future.

"Teacher, I have a question that has been bothering our team for a long time. May I ask for your advice?" I saw a male student with long hair tied in a ponytail raising his hand in the front row to ask. "No problem, please go ahead," I replied sincerely.

"Our technology can be applied in many fields and industries, allowing us to develop multiple products simultaneously. After establishing the company, how should we determine a fair valuation?" When I heard this question, I thought to myself, "It's about time such questions were raised." The value of a start-up company, what is it? How should it be priced? "We don't want our equity to be diluted too much at the beginning, which could potentially allow shareholders to influence our direction of operation." I often hear such thoughts, along with contradictory statements like, "We're afraid of setting the valuation too high and discouraging potential investors." In fact, when start-up teams embark on their entrepreneurial journey, besides ensuring the stability of the management team, the most important aspect is finding long-term funding sources to support the company's operations and ensuring that cash flow can sustain until a stable profit is achieved. Learning how to raise capital through equity dilution is an important lesson that every CEO must undertake, as well as one of the most challenging issues. Equity dilution is closely related to the amount of funds raised and the post-money valuation that represent the percentage of equity that the start-up needs to dilute.

" Why do you think you can capture 5% market share in the first year of product launch and not 2% or 10%? "

So, let's focus on a key question: What is the significance of valuation for start-up companies?

Here, I will briefly provide some insights and hope to help start-up teams, helping them avoid unnecessary mistakes:

1. Valuation should be aligned with expectations: Some start-up teams, despite being in the seed round, seek funding from large venture capital firms, claiming that "the valuation meets the requirements of the investors." However, this may lead to a dead end. Venture capital firms expect start-ups to have achieved certain milestones, such as proof of business (POB) or a solid customer base. If a start-up team believes that having a comprehensive patent portfolio alone justifies seeking investment and satisfies the valuation requirements according to a valuation report, they may encounter numerous obstacles. The reason is that having a multitude of patents does not guarantee successful commercialization. At this point, start-up teams should primarily seek investors that align with their investment stage. While it's possible to find one or two venture capital firms that are interested in the time being, the future environment may change, and the risk of a down round cannot be avoided.

2. Valuation should be based on reasonable assumptions: It is common for start-up teams to approach me with their DCF (Discounted Cash Flow) models and ask whether these assumptions will convince investors. I ask them, "How confident are you in achieving these assumptions? 10%? 20%? Why do you think you can capture 5% market share in the first year of product launch and not 2% or 10%?" The reality is that most start-up teams rely on a "gut feeling" approach to justify these assumptions. In my opinion, without understanding the operational dynamics of the industry, it is impossible to develop a comprehensive business model, let alone a financial forecasting model. Start-up teams should seek guidance from industry veterans, preferably by incorporating them into the team or appointing them as long-term advisors. Financial forecasting assumptions should align with realistic resource allocation and aim to minimize uncontrollable risks. By setting achievable milestones and effectively communicating them with investors, start-up teams can help investors better understand their business philosophy and ultimately reach investment agreements.

In the simplest way possible, I have presented my expectations for start-up companies and hope that all start-up teams can benefit from them.

Finally, I wish everyone success in fundraising!