When you approach an investor looking for them to put money into your fledgling business you must have a good idea of how much you want the investor to put in.   I prefer to see it as how much you need the investor to put in to allow your business to grow to its next stage.  You should also have in your head how much equity in the company you are willing to give for that level of investment.  This gives your business a nominal value.  I say nominal because if your business has not yet made any profits, by the price/earnings ratio method of valuation it’s worth nothing.   Find out what your proposition should be by going through the same series of questions that investors will go through.  In other words, try to see it from their point of view.

Bring to the meeting answers to these questions:

Product or service:                

• In what way does your product offer customers an improvement on what they have now, and what do you think they will pay extra for that improvement?
• If your product is completely new, what new benefits will it bring to customers and what do you think they will pay for those benefits?
• What have you done in the area of patents or intellectual property rights?  You may not have done much but at least make sure you know something about how to go about the process.

Market:

• Who are the potential users of your product?
• How many people fall into that category?  (Make sure it’s a lot; investors want scalability: remember the hockey stick)
• What are the potential routes to market?  Think widely about this, consider international markets, franchising, licensing, using the Internet and so on.  Don’t just think that your first idea is the only way to go.

Sales and costs

·         What estimate can you give of the sales you will make in the next two years and the associated costs of producing the product or service? 

·         How will these numbers differ if the investor puts money into the business?  Make this estimate sensible not fanciful but make it as big as you dare; we’re not interested in small.

Value the business

Now you are in a position to value the business.  Start from how much you need the investor to put in and take into account the profits you forecast. Come to a conclusion, once again sensible rather than fanciful, but go high, make it stretching.  After all it’s going to be hard work so it’s got to be worth the bother.  If you want a rule of thumb make sure the investor will double their money in at the most two years.

After you’ve done numbers the rest is up to you: how well do you sell the opportunity.  Any investor, like the Dragons, will value the company by valuing you.

That’s what we’ll look at in the fourth blog in this series. How do you sell yourself to an investor?

Let’s go up to the top end of company valuations, the value the stock market puts on the shares of a listed public company.  This can be very volatile.  If a number of people are selling blocks of shares in the same company, its share price may well go down.  If lots of people want to buy shares the share price will go up.  This changes the value of the company on a day-by-day, or actually minute-by-minute basis.  That value is often called the capitalisation of the company and is a simple calculation - the price of a share today multiplied by the number of shares.  You can read that value in the financial pages of the newspapers. 

Don’t forget that the value people put on public companies listed on the stock exchange is just the same as an investor in small and medium sized enterprises.  It reflects investors’ opinion of the ability of the company to grow profits allowing them to pay dividends and increase those dividend payments in the future.

Another wee bit of revision from last week’s blog - remember that the best indicator of the value of your house was to look at what people paid for similar properties recently.  So the best indication of the opinion of the professionals working in the stock market as to the value of a company is to look at what recent investors paid for the share.  You get that too from the business pages.

So how does an investor use this information?  Well, they know yesterdays share price and they can find out what profits, often called earnings, the company made in the last year from the company’s web site.  Divide the share price by the earnings per share figure and you get a key ratio known as the Price/Earnings ratio, the P/E.  Knowing how this calculation is made is useful; but investors don’t have to do it for themselves because the journalists on the financial pages have done it for them.  You can read the P/E on a daily basis in the papers or on numerous sites online.

So how does knowing the P/E help the investor to evaluate if a company has little or large prospects for growing its business and its profits?  If the market believes that the company has steady growth prospects the P/E will be low, if the market expects the company to kick up a storm in the future the P/E will be high.  So, a utility company could have a P/E as low as, say, 5 while the market might believe that a high-flying software company might look such an attractive growth prospect that shareholders will still buy the shares when the P/E is as high as, say, 40.

Now in the Dragons’ Den we can get the information on one side of the P/E ratio by asking the person looking for investment what profits, if any, the company made last year.  But we don’t get the other side of the equation because nobody has bought shares in the company recently – there is no share price.  So, that’s what we are trying to assess when people are presenting to us, what is the company’s real potential for growing profits and when is that growth likely to take place.  This allows us to have a stab, if you like, at calculating a fair price for the share.   After all, we are at the start of the chain of company growth that eventually produces the public limited companies of the future.

The next blog will look at what you can do to prepare yourself to impress a potential investor and give yourself the best chance of getting the money.

Valuing a company is much easier if you can detect what experts think is its likely future performance

Into the Dragons’ Den came a chap with a proposition to sell us 5% of his business for £20,000.  I checked that he understood what that meant in terms of his current valuation of his business.  He was well aware that it valued the business at £400,000.  To be honest some people who come in have not done the simple calculation of working out that figure.  If, in this case, 5% of the business is worth £20,000 then the whole business is worth 20 times that.  The revenues of the business were £7,500 in the past year and the profits zero so can that valuation possibly be right?

Funnily enough it might be. 

So how do you value a business?  I’m going to tackle this topic in three blogs starting from this one that concerns start-up companies and small businesses that have been trading for a while.  We’ll get to quoted companies in the next blog and finish off by looking at how to get your company to have the highest possible value, preferably just before you sell all or part of it.

To understand how to value a business, start from thinking about what your house is worth and how you know that.  You can value it in various ways, ask an estate agent, find out what a similar house in a similar location was sold for recently by asking the buyer or the seller or go to a site like www.houseprices.co.uk and get a record of the house transactions in your neighbourhood.  But you can’t be sure can you?  The fact of the matter is that you do not know the exact value of your house until you have not only put it on the market at a price you think sensible but also sold it. 

That’s what market value means – the price that someone has agreed to pay for a house, a sofa, a car or, of course, a business.  So it’s really the buyer who decides what a business is worth.

So how do investors go about it?  Think first about how an investor makes a return on their investment.  They can take a salary as a non-executive director; but that could be counter-productive as it reduces both profits and cash: that limits business growth.

They could take the money out as dividends.  Over the medium term that might give them the return they are looking for.  In order to pay a dividend a company needs two things, first profits over and above its overheads and taxes and secondly the cash to pay it.  More likely the small company investor looks to sell the business for many times the amount they invested to someone who thinks that they can make profits grow even more and that their return could come from dividends.  To make a big profit on selling a business you need two things.  Firstly a huge growth in volume: it’s called scalability.  Investors look for the point at which the business will really take off in terms of sales and then profit.

That’s why the business with sales of only £7,500 might be worth £400,000; but the entrepreneur will have his work cut out to prove it.  He has to make us believe that profit growth is close and very rapid, like an ice hockey stick.

The value of a small or medium sized business is governed by its current profits and its potential to grow those profits into the future

This week’s Dragons’ Den online  included  Darren Fenton  from Northern ireland that Julie and I both warmed to.  His presentation was logical and engaging and he made a really good first impression.  The problem was that the product he wanted us to invest in didn’t have a lot going for it.  If I’m rude, it was a torch with an elongated bit on the top to make it look like a shortened version of the Star Wars lightsabre.  We couldn’t see how it would make money.  The other issue was that if it did start to make money it would take no time flat for a big manufacturer to imitate it and pretty much put him out of business: he had no patents of course, because you can’t really patent a torch!

http://www.bbc.co.uk/dragonsden/entrepreneurs/darrenfenton.shtml

But he was good and I would be glad to talk to him again about the possibility of getting together in a business that sold a product that had legs.

It made me think about how I choose my business partners.  In the end, if truth be told, I invest in people rather than products.  I still want to be sure that what I call a product/market exists.  (Product/markets is a simple concept that says your company does not have a product unless there is also a market.  Ask yourself what am I selling and to whom am I selling it?)  But investing in people means that I look folk in the eye and decide whether they have the passion, the commitment and what I call the business nous to take a product to market.  Darren had all of that and I hope he finds a feasible product/market that will take him into a successful business.

The person that Julie and I did invest in,David Warr,  had a well-developed product with a feasible and potentially large market. 

http://www.bbc.co.uk/dragonsden/entrepreneurs/davidwarr.shtml

I’ve said before that anyone can be an entrepreneur and I believe that; but I’m working on a checklist that people can use to see if they fit into the profile of an entrepreneur now or, if they don’t, what they might do to put their weaknesses right.  Watch this space!

In football they say “Play the man not the ball”.  In business I say hire the person not the product.

My view as an entrepreneur is that there are only two possibilities in terms of shareholdings in companies – you have control or you don’t have control.  I don’t like messy compromises where it’s unclear who can make the final decisions about the way forward for a business.  With the Dragons’ Den investments that I make, I do not normally buy a controlling interest in the business. Though there was an exception in the case of Alex Foreman. http://www.bbc.co.uk/iplayer/episode/b00n46w4/Dragons_Den_Online_Episode_3/

 As a minority shareholder I hope to be listened to where my expertise can help.  I also, of course, have some rights over the future shareholding of the company and, for example, the sale of the business.  But the business belongs to the person who persuaded me to invest and they are, in the end, in control.  I want them to feel that they are really responsible for their own destinies and that whatever I say and think, theirs is the final decision. 

I always make sure that Shareholders’ Agreements make it clear what everyone can and cannot do.  Shareholders’ Agreements don’t need to cost a lot of money to draw up and can be adjusted to fit any conditions that the interested parties agree.

I would hate to lose control of a business where my shareholding should earn me the right to make decisions.  This also concerns lenders.  There’s a case in point at the moment with Blacks Leisure, the outdoor clothing specialist retailer.  They are closing shops and making people redundant at Head Office right now.  Look, I am not saying that such a situation will never exist in a company that you run.  Markets change and sometimes people can find that they have over-expanded their business in, for example, an adverse economic climate.  They have difficult choices to make but at least they are their choices.  Blacks Leisure is having to take action because its lenders are going to put them into administration if they don’t: they have in fact lost control of their business to the banks. Borrowing money can be very useful when you are taking your business forward but remember always to look at the downside of what might happen that would make the lender butt in and take control.

It can also cost a lot of money if, when you have a problem, minority investors or lenders force you to get in consultants and write reports about what you can do.  However clever the report is, you’re still worse off by the amount you have had to pay these people.

The reason you have taken the risk to be an entrepreneur was to be in control and not to have someone bossing you around: keep that in mind as you make your plans.

You can see Shaf on programme Four of Dragons’ Den Online this Thursday at 10pm, on BBC2

In the On-line Dragons’ Den programme the BBC broadcast this week () I made an investment in a business owned and run by Jill Goodchild.  Unusually for me, it is a business that I know the square root of nothing at all about – it’s fashion and costumes.  Jill was looking for £35,000 to take her costume design and production company forward and develop it on the internet.  She designs and makes costumes and sells them to theatres and dance schools.  With the investment money, she was going to get help making the costumes, invest in marketing and develop a web site that would take her into a much larger market – retailing the clothes to, I guess, fancy dress partygoers and so on.

Why I went into a venture that is so out of my normal area of business is a good example, in my opinion, of how an entrepreneur puts a number of things together to make a whole that is much larger than the sum of the parts.

I have a couple of good contacts in the fashion business http://www.checamille.com/

 and one of my management team  has the skills and knowledge to mentor and encourage Jill to grow her business.  Add to this my companies’ experience in working with  web sites that sell products and you can see the synergy that made the idea attractive.

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So, I bought 40% of Jill’s business for £35,000.  I think it’s a good bet and that there will be good growth available to make sure that Jill and I both make money. 

Julie Meyer, the other Dragon in the on-line Den, said a couple of interesting things that I quite agree with and that give good clues about how to present to the Dragons:

• She said that she is looking for investments where the entrepreneurs are impatient and ambitious, not just to take their businesses forward but also to really make them take off.  Don’t look as though your plans are modest if you want to get a Dragon on board
• After I had invested with Jill, Julie also said something like,  “She’s a nice lady; you’ll enjoy working with her.”  That’s important too, I’m in business for fun as well as profit and I want to work with people whose company and style I like

You can step outside your normal business ‘comfort zone’ and go into new areas if you are going to work with people who do understand the industry and whom you can trust

-       You can see Shaf on programme three of Dragons’ Den Online this Thursday at 10pm, on BBC2

Go out and buy a computer peripheral in a High Street or Mall shop.  If you haven’t done it for a while you will be amazed at how cheap things have become.  You buy a colour laser printer for just over a hundred pounds. Think how much it would have been even two years ago.  What happens next? You take it to the checkout counter and the salesperson asks you if you want extended warranty cover for a price that is not much less than 30% of the price of the printer.  It’s very good business for the retailer and gives you reassurance that you will have the printer with no further expense for, say, three years.  It’s a win/win.

EBay have just sold 65% of Skype; let’s think about why.  In daily life, just like in the Dragons’ Den, I see too many people with no long-term strategy for what (and when) they want to get out of their businesses.  Entrepreneurs, venture capitalists, call us what you will; but basically we want out and so should you.  We get our buzz out of analysing a business quickly, buying it, improving it or turning it round from loss to profit and then selling it.

I find it useful to look at another example to make the point. Take dealing in shares. 
Start from the basics.  To make money in shares is easy – buy shares when their price is low and sell them when it’s high.  When I say that to people they get very annoyed and frustrated.  It’s a statement of the bleeding obvious and leads to the question – “Yes, but how do you know what to buy and how do you know when to sell?”

OK, let’s think about it.  How many times have you heard people say “Oh, I bought the share at the right time and it shot up but I didn’t sell it and now it’s on its way down?  I still don’t want to sell it because I’m sure it will recover and go back to the price it was at its peak.”  Let’s think about the logic, or rather illogic, of that statement.  In the first place they’ve done well.  They bought a share and it went shooting up, their timing was good.  Why didn’t they sell it?  The only logical reason is that they thought the share was going to go further up.  But is that logical?  After all if a share goes up by 25%, what are the chances of its doing so again?  I know there are special circumstances when this might be the case but that’s probably unusual.  If you want to deal in shares buy them when they are at a low price and remember to sell them when they have gone up.

The second part of the statement is equally fallacious.  If a share goes down it is for a reason.  The market, who have got a lot more time than you to study these matters knows something that is making them take their profits or cut their losses.  When a share goes down - sell it, is a good rule of thumb.  After all, if a share goes down from 100 pence to 50, it has collapsed by 50%.  In order to go back to 100 pence it has to rise by 100%.
I find it useful to use the example of dealing in shares to ex plain how dealing in businesses is exactly the same.  The point of being an entrepreneur is to buy companies for a low price and sell them for a higher one.  The art of being an entrepreneur is to know which ones to buy and when to sell them.

So, EBay is selling 65% of its share in Skype for a sum of money much less than the value they bought it at.  Quite right; they made a mistake, Skype was not the strategic fit they thought it was and they’re cutting their losses.  We can all learn from them.

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The promotional materials like fliers, brochures and emails that come into my inbox or letterbox often surprise me.  Many of them are telling not selling.  They’re describing their product rather than working out from my point of view the benefits to me of buying it.  Let’s look at an easy example first to make the point.  Have you ever enjoyed buying a computer?  A lot of computer salesman are, fortunately, very knowledgeable about quite a complex product.  The good ones can listen to your requirement and then describe the features of their products in terms of how it answers your needs.  They find out what you are going to use it for and say things like, “OK, if you have to print out large reports there is probably a good return on investment in the top model in the printer range.  It’ll save you a lot of time.”  They don’t say, “This printer has a rear entry sheet feeder that holds up to 100 sheets of 64gsm paper, printers up to 32ppm with a maximum of 5760 x 1440 dpi and has an input memory of 64KBs”  You can enjoy buying from the first one; the latter can be a nightmare.
Look at your promotional material with this in mind.  Does your passion and knowledge make you put in too much about the detail of the product, and not enough about what it does for the consumer? If you’re selling gifts, for example, make your first question, “Who’s it for?”  That way you can talk about the how the recipient will enjoy it.
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Tip from Shaf – Focus your advertising on your market
A good way of designing your brochures and so on is to think of the newspaper that your target market reads.  This gives you the level and feel of what your stuff should look like.
 
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Take time to consider your target audience when you are designing promotional materials.  What will make them read it?  Remember it’s quite easy to open a promotional letter and only half take it out of the envelope before binning it.  So you need a simple benefit statement or question to get their attention.  Keep it simple.
 Look too at your order forms and contracts.  If they have more disclaimers and conditions of sale on them warning people why they shouldn’t buy, than benefit statements saying why they should you’ve got it upside down.
Web sites also are often poor silent salespeople.  They’re difficult to navigate and frustrating to use. For an example of a clean uncluttered website which is easy to navigate have a look at the website www.estock.co.uk
 
Whatever you sell and whomever you sell to maintain a professional and smart appearance about everything the customer sees with your name on it.

Lots of people talk to me about starting their own business.  Some of them are obviously just ‘talking the talk ‘ and have no intention of getting round to it.  I call these people the superglue entrepreneurs – they stand on the top diving board saying they are about to take the plunge when in fact something, probably risk aversion, has super glued their feet to the board.  The second type of would-be entrepreneur complains that they would start off on their own if they just had a little bit of capital.  To them I always say “You could have at least £500 in capital in two to three days.  Just sell some assets.”
I’m not talking about the family silver here I’m talking about the stuff in the attic, the presents you didn’t want and other detritus that you never got round to throwing away.  And it’s easier now.  Selling your unwanted stuff no longer needs to involve car-boot sales – use the internet and you can get more customers and better prices.
There are two routes into online selling. Firstly you might just want to declutter your home a bit and raise £500 as a grubstake for your new business. (Incidentally, the glory of offloading your second-hand goods and chattels is that any income you make is almost certainly tax-free.) Alternatively, you might want to consider setting up a fully-fledged online business. For many people who have taken this route, their business is based around a hobby or passion.  A mate of mine is a fishing  fanatic and started a business selling on the Internet his old Fly Fishing equipment along with anything  that he picks up at car boot sales and junk shops – his work is his hobby.