AskPiers: #3

Updated: Oct 31, 2018


You asked and I have answered. Questions from Ben on whether to outsource telesales and from Stephen on how to value a technology


Should you outsource telesales?


Hi Ben - I have been around in circles on this myself in the past and have outsourced telesales, or at least lead generation, to agencies with mixed success. You have to balance the costs and benefits of internal resource and developing your own capabilities against outsourcing.


There are many variables, but my core advice is as follows.


Don't outsource key functions


A young business should avoid outsourcing key functions that are fundamental to success and business value and learning. Outsource and/or automate everything else so that you can focus on adding value to sales, marketing, operations, product, personnel and stakeholder relationships. If you plan to sell your business one day, what is a buyer going to want – if it is just cash flow generated by an aggressive sales strategy starting with outbound telesales, then it may be OK.


Sales and marketing is a key function, but that can be broken down as you progress through your pipeline. Even a startup can outsource lead generation to a competent partner with good data and with a tried and tested approach or script. It is possible that you have experience of this in past employment and know how to maximise results. However, as your prospects, become leads and then opportunities, it is more difficult to outsource to a third party to close the sale, especially if your product is new. Also, you will miss the opportunity to learn from feedback and mistakes and the opportunities that couldn't be closed. Doing it yourself, or at least internally, means that you will receive first-hand feedback instead of a report from a lead generation partner.


Your telesales partner can move on to the next client, whereas you have to start again from scratch and that can take time and hit revenue hard.


Manage the Relationship


If you are going to outsource, then do your homework on your partner and structure the contract to manage your risk. You can find yourself locked into underperforming relationships very quickly. Ensure the data is high quality otherwise you are wasting your time. Make sure that you are engaged upfront to ensure that your telesales partner and the people on the phones understand as much as they need to and maintain ongoing quality assurance. Manage the relationship closely and use the data and feedback available to iterate and improve to maximise your return on investment.


I would add that customer service is the same. Yes, you can outsource first line or out of hours customer service, but in the early days hold on to your customer engagement. No third party will ever understand your product like you. Customer feedback is critical to product development and improving sales and marketing performance.


How do you value a startup?


Hi Stephen – I used to value companies for a living as an investment banker. There are many complex methodologies such as comparable companies analysis (trading valuations), comparable acquisitions analysis (exit valuations including premia), discounted cash flow analysis (DCF), economic value added (EVA) and so on.


More mature businesses have track records of performance and cash flows – for example it is easier to calculate the value of a utility company using a DCF as they have secure, long-term cash flows, but you may still want to factor in regulatory risk.Whereas a startup may just have a plan to launch a new product in a new market segment – the lack of data points means that startups are very hard to value using the usual techniques.


Scaleups are more likely to have some track record, plans based on experience and comparable companies in the market. Companies are usually valued by comparing them to similar ones with adjustments made for rates of growth, intellectual property, real assets, maturity, margins, capital structure and so on.


Valuation metrics


Still research comparable companies even if they are not identical, but have similar characteristics. For example, generically, established professional services or consultancy firms are valued at around 1x revenue. Tech companies are often valued at multiples of revenues and not profits – as there may not be plans to generate profit for some time.

Valuations based on revenues are focused on growth and the assumption that at some point a profit will be generated.


Valuations based on multiples of numbers further down the profit and loss statement, such as on net profits, factor in margins, costs, capital structure, tax and so on. Price-earnings (PE) ratios are a measure of the value of a company compared to its net profits (earnings) and are easier to calculate for public companies as there is a share price to use as the numerator and the earnings per share (EPS) can be used as the denominator. In the case of private companies start by looking for similar public company comparables.


Also research venture capital and angel investment deals and pull the records from Companies House (UK company registry) or look on databases such as CrunchBase for any information that may be available. You can work out valuations from just a news article or press release and publicly available accounts, although accounts may date quickly if the company is growing rapidly and investing heavily.


Reverse engineering

If the scientific approach doesn’t produce a sensible answer, another way to produce a valuation is to look at the business plan and exit valuation potential and then reverse engineer the valuation you can accept based on your return expectations, with a substantial discount to factor in risk. For example, if you think the company could be worth 3x revenue in 5 years (i.e. £15 million) and you want a 5x return, you can’t value the company at more than £3 million today. If you are investing at the seed stage, the risk is very high so the valuation should be far lower, unless £15 million is your risk adjusted exit valuation due to a proven team raising a significant amount to startup. Obviously, tax breaks such as SEIS and EIS (UK) can have a material impact on your risk, entry price and taxation of any capital gain at exit. This approach is by no means scientific, but it can sense check the valuation being discussed.

It boils down to...


Even with decades of data and sophisticated models, valuations are still estimates and they can’t factor in new technology, nascent yet disruptive competition or a sudden change in consumer trends.


It boils down to this.


Anything is only worth what somebody is willing to pay for it.


If you are the only show in town, then you are the market. If you are competing with several interested parties, then one will normally lead and set the price. You have to weigh founder incentive (there is no point leaving the founders with 5%; likely future dilution and funding rounds, risk, availability of tax breaks such as SEIS and EIS (UK) and your opportunity cost of using that money to invest in another company or go on holiday.


How hard do you want to negotiate? Typically in a seed round of £100,000 to, say, £250,000, investors will be issued with shares representing 20% - 49% of the business. If you want control or if the founders need a huge amount of help and you are going to take an active role, then you could tip over 51%, but a minority interest is the usual outcome for investors at this stage.


If you have a valuation gap that has lead to an impasse you can close a valuation gap by providing the founders with the opportunity to claw back equity if the business performs or after reach your return target. In the case of two tranches, you might want to agree on financial performance or operational milestones (e.g. MVP completed) before the second tranche can be drawn. The reality for founders is that unless funds for future tranches are literally held in escrow for release by a lawyer when specific and measurable conditions are satisfied, they are not certain. If the targets or milestones are not reached you can agree a mechanism to adjust the valuation that was applied for the first tranche or re-open negotiations.


You can structure some of the investment as a loan or a convertible so you convert if things go well and seek repayment if they don't, but at the seed stage equity is more normal and represents risk taken. You can be creative, but remember that future investors will probably completely restructure the deal if it is too complicated and add layers of preferred returns before ordinary shareholders (SEIS/EIS compliant shares) receive a penny.

In the end you have to agree on something that works for you and the founders and which results in aligned interests. Investors can manage risk in contract with veto, consent, board representation, step-in, tag, permitted transfer and information rights. These are typical terms you wold expect in a shareholder agreement and there are many more to consider. The founders will want protections too such as you not being able to just sell your shares to somebody in a bar.

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