How to do startup valuation when approaching angel investors – some thoughts from the Malaysian perspective

Steason Tee

When approaching angel investors for fundraising, early stage startup founders should know what goes on in the minds of angel investors, in terms of how they value startups

First, lay down the funding stage definition:

  • “Angel” or “Pre-Seed” stage is defined as the startup having no up-and-running business or the business is in Alpha or Beta stage, and the valuation is around RM2.2 million (or US$500,000).
  • “Seed” stage startup is defined as generating minimal revenue or none, and the valuation is around RM4.4 million (or US$1 million).
  • “Pre-Series A” stage startups are not ready to go into full-scale commercialisation or yet proven a consistent growing revenue and thus need to raise fund for completing the R&D. The valuation is around RM11 million (or US$2.5 million).
  • “Series A” stage startup has emerged into a full-scale commercialisation path and generating consistent (+growing) revenue monthly, the valuation is RM17.6 million (or US$4 million).

What about Series B? Series B is the stage in which the startup had figured out a winning formula to scale up the revenue rapidly and plan to expand the market. The size of funding required is so huge that it need a sizable number of angel investors to participate with large ticket size. Hence, startups often approach VCs for post-Series A funding stage, instead of angel investors. In this discussion, we will ignore Series B and above scenario.

Risks and returns

The earlier the startup stage, the higher the risk that angel investors would expect the investment will get wiped off. Early stage startup investment is a very high-risk asset class, which often have a higher risk than private equity investment and hedge fund. The liquidity level in this risky asset class is extremely low and the time it takes to exit is long, as well.

The angel investors would always expect one or a few of their early stage startup investments wiped off. Given its risky nature, angel investors would only invest if they expect a minimum IRR of 18 to 25 per cent depending on the vertical. An IRR of 25 per cent is indicating a startup is doubling it’s valuation within three years or tripling its valuation within five years.

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Series A stage startup carries less risk than Angel stage startup and hence angel investors expect a lower IRR. Angel stage IRR should be around 25 per cent, Seed IRR 22 per cent, Pre-Series A IRR 20 per cent and Series A IRR at 18 per cent.

Angel investors know that not every startup can achieve an exit as a Unicorn (US$1 billion valuation), nor Centaur (US$100 million valuation) or even reaching Pony (US$10 million valuation). However, reaching Pony stage is reasonable to expect. Hence, the angel investor is often expecting a RM44 million (or $10 million) valuation when the startup exits via IPO or trade sale. Trade sale opportunity is too uncertain to be treated as exit strategy, as compared to IPO.

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Exits and valuations

In Malaysia, the lowest barrier to execute an IPO is ACE Market. ACE Market currently has 114 listed companies and more than half of them have a market cap of below RM100 million (US$23 million) mark. 67 companies (60 per cent of ACE) having a market cap of below RM100 million, 34 companies (30 per cent of ACE) having a market cap of between RM100 million to RM250 million (US$23 to US$57.5 million), 10 companies (9 per cent of ACE) having a market cap of above RM250 million.

For the 67 companies whose market cap is below RM100 million, the average valuation is RM55.6 million (US$12.66 million), median valuation is RM49.6 million (US$ 11.2 million), average turnover is RM62.54 million (US$14.39 million), average revenue multiple is 4.4 times, and average PE ratio is 31.6 times.

The previous paragraph mentioned that investors are expecting a RM44 million (or US$10 million) exit valuation — this is further echoed by the fact that majority of the ACE companies’ valuation is around RM50 million.

So, we are now clear that what’s the valuation range should a startup falls into. If a startup wants to raise at a higher valuation despite its asking at a stage which it doesn’t belong to, an angel investor might think one question repeatedly: “Can this startup beat ACE-listed companies?”

Let’s look at the examples below.

Example A

“Startup A” approaches an angel investor with a valuation of RM30 million and turnover of RM3 million, consider it a “Series A” funding stage. Just to be clear, the RM30 million valuation is almost half of the exit valuation of RM50 million.

An angel investor who wishes to achieve at least 18 per cent IRR from this Series A investment would expect this startup can achieve an IPO on ACE market at RM50 million as an exit strategy within 3 years timeline. It sounds too aggressive when investor look at its current revenue of RM3 million. If the startup wants to garner RM50 million valuation during IPO with revenue multiple of 4.4 times, the revenue at IPO year will be hitting RM11.36 million.

From revenue of RM3 million scale up to RM11.36 million within 3 years, the revenue CAGR is 55.87 per cent. How realistic is 55.87 per cent? One of the Malaysia most successful tech company MYEG is achieving a 5 year revenue CAGR of 36.8 per cent and MYEG is constantly recognised by Forbes as one of Asia’s “Best Under A Billion” companies. Angel investors’ going to be thinking if this startup asking at RM30 million valuation, the startup gotta shows that they can perform better than MYEG (RM7.8 billion or US$1.8 billion market cap company).

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In this example A, clearly a number of angel investors would walk away from this deal due to its current revenue is too low and asking at a high valuation.

Example B

Using the same startup A as the reference, the changes now is the valuation lower to RM22 million instead of RM30 million. The startup is targeting a 5 years timeline to achieve revenue of RM11.3 million and list on ACE market at RM50 million valuation. This derives from the same revenue multiple of 4.4 times, gives an IRR of 18 per cent with revenue CAGR of 30.51 per cent (revenue RM3 million increase to RM11.36 million within 5 years).

In example B, the angel investors are now seeing a reasonable valuation with realistic CAGR and finally a good balance of risk and reward at IRR of 18 per cent with 5 years timeline.

Have a word to say? You are welcome to join the discussion below.

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Disclaimer: Although I’m from Crowdo Malaysia (Malaysia’s licensed Equity Crowdfunding platform), the point of view above doesn’t represent the platform’s view. It’s solely my personal view and a collection of views by my personal interaction with angel investors.

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