How Online Angel Sites Change What Angels Need to Calculate
The rise of online angel investment sites have changed a key calculation that investors need to make in screening potential opportunities. In the pre-online world, angels needed to estimate a reasonable pre-money valuation for start-ups seeking financing.
In the pre-online world, angels needed to estimate a reasonable pre-money valuation for start-ups seeking financing. But in the world of online angel investing, the pre-money valuation is often a given. What the angel needs to figure out is whether the potential harvest value of the company would support it.
One good way to do this is through algebraic manipulation of the Venture Capital Method for calculating the pre-money valuation of young companies. Bill Payne, an expert business angel and mentor, published a great blog post summarizing this method, which I draw upon to show the necessary algebraic manipulation.
With the venture capital method, the investor’s return equals the venture’s expected harvest value divided by its post-money valuation. So to calculate a post-money valuation, investors take their estimate of a company’s harvest value and divide it by their desired return multiple. Then they subtract the investment sought from the post-money valuation to estimate a pre-money valuation.
On online sites for angel investing, the pre- and post-money valuations are often given. So, instead of figuring out the pre-money valuation for a startup based on an estimate of the expected harvest value, an investor can calculate the needed harvest value-based return expectations and the pre-money valuation.
The key to this effort is having an appropriately high return expectation. Studies(PDF) show that the returns to angel investments are highly skewed. Most lose the capital invested in them or barely make it back, while a small fraction (around 10 percent) provide a more than 30 times return. These few winners make up for all the losers and provide a healthy return on the investors’ capital and time.
The catch is that no one knows…