One of the biggest barriers in valuation is our bias that affects how we perceive an asset or a company. Unlike writing, which we often do on a clean slate, valuation never starts with a clean slate.
We almost always have something to work on, a preconceived notion that affects us. It can be as innocuous as hearing what others think about the company or if there was a high profile industry takeover that just happened.
Valuation, hence is almost always worked backwards. It starts with how much money you need and how much equity you are comfortable in giving away. We look for how similar companies are priced and so on. With this in mind, a number is assigned to the company.
The potential for abuse in such cases is immense, since you will always pick a company that reflects the bias that you have for that firm. This inaccurate valuation often leads to founders giving too much equity and fosters bitterness between investors and founders.
There has been very little innovation when it comes to the way we raise capital. We have subconsciously (again!) believed in the notion that data cannot be applied to venture financing. The common myth is that companies can only be valued by looking at similar companies.
What then is the solution?
There is a contrarian view that is increasingly becoming popular.
We can value a company by first principles or through Discounted Cash Flow. It allows us to look at the building blocks of the company. Yes, there are going to be assumptions and there might be biasness, but these assumptions are explicit and we are honest about it. The discussions on these assumptions turn out to be invaluable.
And a discussion on those topics would help you discern which investor is a right fit. Remember money is just one part of the equation, ultimately you are looking for a long term partner who is in sync with the way you want to build the company. And DCF is one of the best ways to value as well as find an investor.