joined:Apr 1, 2016
I'm trying to figure out how to get the valuation of everything right along with the amount of cash to contribute
Valuation is basically the present value of future earnings plus goodwill.
Goodwill being the intangible value that the business has, such as it 20 years of history, its client base, brand recognition, domain name, and so on. These things can hold a lot of value in some circumstances. But really this is the most difficult to assess.
The present value of future earnings is straight forward. Just go back in time a certain amount, say 5 years and project those earnings into the future, then discount them by some rate of return. If earnings were steady with little variability you can take a low rate of return (say 10%) and if your earnings fluctuated a lot then you use a high rate of return (25 to 50%). A lower a rate of return will result in higher valuation. It is very possible, if you are loosing money that this portion of the valuation will result in a negative value. This is specially true if the business is carrying debt, in which case the negative value needs to be subtracted from the Goodwill. Choosing the right rate of return is the important part here, and since there is no "right" rate of return per se, it comes down to what the investor are willing to accept (ie: to be negotiated).
The important thing in carrying out this valuation is not to take into consideration the benefits that futures changes will make. Example, if an investor comes in and invests 100k to rebuild and then you expect that the website can double it sales. One should not take those doubled sales into account in the projected earnings. You don't have the 100k, you don't have the doubled sales. The value is calculated based on the business as is today.
This valuation may be very academic and subjective but it is a good exercise to determine where the company is at and provide a an objective basis for negotiation and decision making. If you undertake the exercise with your employee you will both be able to view the business from them same perspective. Then you can negotiate on the subjective elements, namely goodwill and rate of return.
...right along with the amount of cash to contribute
The question of how much cash to contribute will depend on the valuation of the company. If you are transferring a portion of ownership of the company this is equivalent to investing that % of the valuation. Now to determine the valuation of any additional cash that will be put into the company, this is the expected change in earnings that the investment will bring. If you expect that the investment will increase sales by 10% then you take the dollar value of that 10% projected into the future and discount to the present value with a rate of return. This rate of return does not need to be same as the previous one, it will likely be higher because to make projections into the future with no historical data is far more risky than predicting the future of an established business. (side note: the rate of return is based on estimate of the risk or uncertainty of the business, more risk higher rate of return) Once a present value (PV) is calculated take that amount divide it by the your share in the business and that is what you should contribute in cash and equity. Say you plan to contribute 100k (cash + equity) and you calculate the PV to be equal to 50k, then you should either not make that investment or make changes to the business plan such that the valuation coincides with the investment.
I hope this helps...