If I have a startup that produces a product that I estimate to sell 100/per month, with 50%profit, and $200 is the customer price of each product, How can I evaluate this business to find investors?
First of all, valuation, especially for startups, is a topic without much consensus on the single way to do it. You can take several approaches, such as DCF, multiplayer, prepetuity and EVA (or residual income).
One frequently used way to make a valuation of projects and businesses is to use the Discounted Cash-Flow model, where you estimate the profits and losses for each year, including the financing and the depreciation you would have from the initial investments. This will give you the expected net result of the project, discounted to today (the net present value).
As some startups have difficulties in projecting costs and revenues, alternatives such as the multiplier method are used by some entrepreneurs & investors. I do not consider this method very accurate, as it is easily manipulated by the choice of multiplayer.
Go beyond the numbers
If you're looking for investors to fund your large initial investment, you usually need to provide proof that you can actually sell to your customers. If you could get customers to sign already a future commitment to buy this would help investors trust you and fund you.
You can also try to resort to debt or public grants for starting a business, or try to anticipate some sales revenue to finance your startup. Get legal advice before signing with an investor, this is critical to ensure you still get a fair share of the deal.
At the time of writing this answer, the question is missing key information: the amount of capital needed, and the lifetime of the equipment bought. Based in the comments, the amount to be invested is \$150,000, and I will leave the equipment lifetime to be a free parameter.
- Before starting a small company, look into statistics for business failure; most do. I believe that lack of business knowledge is a common cause of failure.
- Your first stop should be a business development bank; in Canada, it is a government-run agency. Even if you do not get funding, they will tell you how to set up a business plan.
- If entering into a private contract, you need a lawyer. A good small business lawyer probably knows a lot about valuation.
Until you have cash flows, or the asset purchased with the \$150,000 holds its value (very unlikely) debt finance is not an option. If you have a proven revenue pipeline, you will have an easier time.
So you are looking at equity finance. You effectively own 100% of the business, what percentage of the firm’s equity do you give up in exchange for the \$150,000 investment? That is going to depend on what you can negotiate. If you are not putting in any of your own capital, the starting position is that you get 0% of the equity. There has to be some reason why you are getting a bigger piece. That’s for your business case to explain.
However, you need to offer a return to the investor that is greater than the his/her hurdle rate. Small businesses are risky, and so the hurdle rate is very high.
The minimal ownership percentage is: Ownership % $\geq$ (Target \$ return)/(Expected total firm profit).
Note that if the investor expects a lower profit than you, the percentage of the frm demanded woukd increase.
Your numbers indicate that you will have an annual net profit of 12*100*\$100 = \$120,000.
The simplest hurdle rate technique is that the investor wants to be paid back in a fixed time, often 2-3 years. So that would imply an annual return of \$75,000 - \$50,000. If the investor accepts your profit projection, that would imply getting around half of the equity (at the minimum).
The next way would be to use a discounted cash flow technique. In Microsoft Excel, this can be done with the PMT() (payment) function. (Presumably other spreadsheet packages have the same function; it is built into financial calculators.) You can experiment with the parameters.
The most generous valuation I could come up with is a target return of \$55,800, using parameters:
- Rate = 25%
- nper (number of periods) = 5
- PV (initial investment) = -150,000
- FV (future value) = 0.
This is saying that the investor wants an internal rate of return of 25%, and paid back over 5 years (which is assumed to be shorter than the lifetime of the equipment).
Once again, these are the minimal profits levels needed to even start negotiations,
Unless you can find an understanding investor, the easiest course of action might be to clamp down on your personal expenses and build up a stock of financial assets to put into the business.
I would evaluate your start up based primarily on 2017's net revenue. Outside of that your idea is only worth something to a person who happens to put value there which apparently is a small percentage of population. So basically start looking for start up capital is your question preferably reducing personal liability which will likely being a trade off and terms for the venture to generate investment.
Simple, you have a perpetuity, thus will need to discount all future cash flows to find Net Present Value, which essentially is the net worth of your company:
100 * 200$ * 12 months * 50% = 120,000$
You will then divide that by your interest rate, perhaps your average weighted cost of capital, WACC. Let’s say it is 5%.
120,000 / 0.05 = 2,400,000$
Which would be the Net Present Value of all your future cashflows; given the information you provided.
This is true because you specified a specific cashflow without growth for all eternity, hence the value of your cash flow in year 50 is going to be worth very little in today’s money.
EDIT: Forgot to take into account that there are 12 months in a year; answer has been updated.