Enhancing Start-Up Valuations: Target Markets and Pre-Revenue Sales Projections.

In an earlier blog, I suggested that an inventor/entrepreneur must ask and answer five questions before deciding to start a new business.

 

Here is Question #2: Is there a significant market for products to be made or services to be provided?

My comments and answer.  

One of the more difficult issues for entrepreneurs to address relates to target markets and potential sales revenue.

It is critical at the earliest stage of planning and due diligence by founders to determine those markets (e.g., the target markets) that are sufficiently large and growing that they would support the entry of a new competitor (the entrepreneur’s new venture). Professional investors generally insist that target markets be large and growing so that missteps and errors on the part of the new venture can somewhat be compensated by the size of the market which presumably contains large competitors who are not particularly concerned with competing with a small, up-start, technology company. Nevertheless, venture capital firms, in particular, are interested in supporting companies that target billion dollar markets rather than those that target million dollar markets. Both the magnitude of investment considered and the interest of professional investors scale with the size of the markets to be served by the underlying technology.

The goal for an entrepreneur is to identify a number of potential target markets that collectively (in a summed sense) have a large size, presumably in the billions of dollars range. One of these target markets will eventually be selected as the entry market — that market that offers the best prospect for producing profit soon after funding. That initial target market need not be large, but it must be one for which success is highly probable.

The weakest part of any business plan will be the projection of sales revenue. Investors, for good reasons, dissect sales numbers and also carefully study the rationale behind the projections. The inability of the entrepreneur to adequately explain or validate how sales will be accomplished gives investors the opportunity to discount proposed valuations. The entrepreneur is usually ill-prepared to defend the business plan in the absence of a good, if not excellent, marketing and sales strategy and plan.

For a new venture without any evidence of sales, sales revenue needs to be projected using a combination of provable data about the markets and assumptions and judgments about how prospects are converted into customers. These assumptions and judgments will still be examined closely by investors but they are more defensible and subject to testing (surveys, focus group, for instance) at early stages by the new venture. With early testing, sales projections become more credible and less subject to discounting by investors. This provides a pathway for entrepreneurs to argue for greater pre-money valuations. 

 

More detailed information about developing robust pre-revenue sales projections are discussed in my book, The Smart Entrepreneur: The book investors don’t want you to read available on Amazon in September 2014. 

 

Question #2 must be answered YES to continue moving forward.

 

See my author web site at www.rockyrichardarnold.com.

All questions and contributions are welcome.