Abridged Version. For a complete version, please send a request to jeff@navocate.com

1. Capital Readiness and Pre-Money Valuation
by Jeff Greenspan (jeff@navocate.com)
In my previous article about capital readiness, our perspective was from the funder’s side. And while it is
useful to take that perspective as we get close to a funding “event,” there are a whole host of activities
that can and should be accomplished long before you even consider outside money, and these activities
start at the inception of your company. In this article we will consider the activities that should occur
before you look for capital, up to and including a pre-money valuation. The first two sections apply to
every company; after that we focus on companies that will be raising capital.
Section 1: We’ll start (and spend some time) with critical documents. I am going to strongly suggest that
you create and maintain both an electronic and a physical record of everything that we discuss in this
section1
. On DAY 1, buy a premade company binder, or create one from scratch. At the same time create
an electronic folder with a corresponding structure. By organizing your documents with the following
structure, you will be ready if the next phase of your company’s growth includes outside stakeholders.
Since most of this list is self-evident, I’ve included only a few comments. It should also be obvious that
no company will have all of these documents.
[The list in this section has been removed for brevity. Please send an email to
jeff@navocate.com with the subject line Corporate Documents for an unabridged version of
the document.]
Section 2: The second area that needs attention is your accounting system. Sounds boring, but it’s not!
For those talented enough to interpret them, your books tell their part in the story that is your
company. Help people read that story by organizing your revenues and expenses along product lines, or
service lines, or some other method that makes sense. Here are two examples:
THIS IS BETTER THAN THIS
Service Revenues
Project Revenue
Managed Servers and Workstations Rev
Backup & DR Revenue
Firewall Monitoring Revenue
Email Hosting Revenue
VoIP Revenue
Service Revenue
Project Revenue
Managed Services Revenues
Product Sales Revenues
Server Sales
Workstation Sales
Laptop Sales
Peripherals
Accessories
Product Sales Revenues
No subcategories
1
You’ve heard of Continuity of Operations planning, right? It is one sign of operational excellence.

2. Each revenue account should be matched by a corresponding expense account: this allows the reader to
determine profitability by product line from your Income Statement.
The concept is simple: how can you organize/augment your accounting system structure in a way that
adds useful (actionable?) information to your financial reports. This can require accounting creativity.
Section 3: If you are thinking about raising money, we should discuss your business plan. You have one,
right? If you don’t have a business plan, you at least have a Business Model Canvas (Strategyzer.com) or
something similar? [Phew, I thought I was going to have to send you packing.]
Your business plan tells the story of how you are going to monetize your idea. It may also tell the story
about how your company will change the world. In either case your story should have a compelling set
of arguments in favor of your success. Here are four arguments that I like to see:
1. Prove your numbers. Can you demonstrate the validity of your sales assumptions? How much
will it cost you to acquire a customer? What renewal percentage are you expecting for your
subscription service? Many of these numbers are buried within formulas on your Proforma
spreadsheets. Bring them to life by making them parameters, putting all parameters on a
separate worksheet tab, and including definitions for them. Explain how you selected the value
for each parameter, and indicate your level of confidence in the value you selected.
2. Prove your business skills. Work your business model. Show me that you understand how to add
value to your business by focusing on parameters that have greater impact. You can do this with
sensitivity analysis and optimization. Do changes in the cost of raw materials have a larger
impact on profit than changes to the cost of labor? What is the expected value of adding more
resources in R&D? Where are the bottlenecks in your processes?
3. Pre-sell your idea. The real proof about whether you will be successful arrives when you
convince people to pay you for your product/service. Even if you have no product or service yet,
you can create a “Pre-Sales Agreement” or “Memorandum of Understanding” in which a
customer agrees to pay you when you meet specific criteria. For example, a hospital agrees to
pay for 500 tests at $x/test if you can demonstrate that false positives are less than 2% and false
negatives less than 0.5% within a one-year time frame. In my judgment the concept of a pre-
order or pre-sale is one of the strongest arguments in favor of a business that can be made.
4. Connect the dots about how you will monetize your idea in the Executive Summary.
Each section of the Business Plan has a purpose. Don’t leave me guessing whether you know what that
purpose is.
Section 4: If you are thinking about raising money, tell me how you are going to use it. Your capital
deployment plan should tell the story about how capital enables you to monetize your idea.
Parameterize, analyze, and optimize this information. You want the reader to understand how each use
of funds will contribute to the company’s success.
Section 5: Valuing your company is difficult if you are in a pre-money scenario, but the process is made
easier if you have complied with the earlier sections. All pre-money valuations are based on a
discounted cash flow methodology, which asserts that the value (today) of $1 earned at some point in
the future is less than the value (today) of $1 earned today. The discount applied to that future value is a
judgment call based both on market factors, like investor expectation of return, and on risk. You cannot

3. affect the former, but you can have a profound impact on the latter. Discount rates range from a low of
about 7% to a high of about 35% per year. That means $1m in revenue at year 5 will be valued
somewhere between $712,986 (7% discount) and $223,013 (35% discount). To calculate the discounted
cash flow of $N in year X with a discount percentage of Y%, use this formula: DCF = $N / (1+Y%)^X.
To arrive at a DCF Valuation, follow these steps:
1. Pick your cash flow. [See discussion below.]
2. Pick your discount. Many evaluators use a discount range to arrive at a range of values. If you
would like a sample set of ranges for five different categories of risk, I will happily email one to
you.
3. Apply the discount to your cash flows to get the present value for each year. Typically a finite
time period of 5 years is used.
4. Sum the present values and subtract any long term debt.
Three estimates for cash flow are commonly used. Net Operating Income (NOI) is defined as gross
income less operating expenses less depreciation less amortization. Earnings Before Income Tax (EBIT)
adds any income taxes back in to the NOI. This makes sense in many cases because the impact from
taxes varies depending upon your entity type and existing NOI. In the technology space, Earnings Before
Income Tax, Depreciation, and Amortization (EBITDA) is the most commonly used measure of cash flow:
it is also the cleanest, as the excluded expenses a) often vary and b) do not reflect costs associated with
generating revenue. Because NOI is less than EBIT which is less than EBIDTA, NOI will generate the
lowest discounted cash flow value and EBIDTA the highest.
Now we can consider a simple example with an imaginary flow of EBIDTA and an imaginary $800k loan:
About the author: Jeff Greenspan, an Associate at Navocate, is an entrepreneur who successfully exited
the technology race and now helps other growth-oriented technology companies grow, both through
M&A activity and capital acquisition. Mr. Greenspan is actively “making a market” in the SMB IT space,
helping buyers and sellers find each other. He can be reached at jeff@navocate.com