Startup valuations provide light on a company’s potential to raise further funds in order to expand, satisfy client and investor (Venture Capitalists) demands, and reach the next goal. At this time, there are hundreds of companies with unicorn valuations—that is, ones worth $1 billion or more. Today, there are “decacorns,” firms valued at $10 billion, and even “hectocorns,” startups valued at more than $100 billion.
These calculations are remarkable, but they aren’t as unbiased as you may believe. The skill of your team, your product, your assets, your business plan, the total addressable market, competition performance, the market potential, goodwill, and other considerations may all be taken into account when valuing a company.
Using hard economic data as a starting point is possible if you have genuine revenue. However, in the context of fundraising, the value of your firm ultimately depends on what you and your investors determine to be appropriate. Additionally, most venture capital companies and angel investors employ a variety of formulae to determine a business’s pre-money value, or how much it is worth before they invest.
Putting a startup’s value is both an art and a science, it’s fair to argue. Understanding the various business valuation techniques will be useful whether you’re in the pre-seed stage or are only giving stock options to your staff. We’ll cover eight techniques in this post that you may use to appraise your firm and be ready for upcoming fundraising discussions.
Knowing the essential elements investors in startups take into account
Investors fall into several groups, including angels, venture capitalists, high net worth individuals, family, accelerators, and incubators. Regarding the industry, performance venue, audience size, company strategy, etc., these investors (Venture Capitalists) have their unique investing philosophies. Any investor will only invest in a company if it makes sense for them to do so. Early-stage investors often invest in firms that are in the ideation, launch, product development, pre-revenue, alpha, or beta stages, i.e. MVP.
Given the demands and dynamism of the market, investors are eager to invest in startups that are associated with a hot industry. For instance, the post-pandemic environment has led to a rapid increase in early-stage businesses in the fields of healthtech, edtech, logistics, supply chain management, food tech, and many other areas. Additionally, the investor (Venture Capitalists) scrutinises the company plan for income streams and scalability. Prior to learning the startup’s worth, investors often check for client traction and the likelihood of repeat business.
- Berkus Method
A popular approach used by many investors (Venture Capitalists) to determine the value of startups is the Berkus Method, which bears the name of well-known American angel investor Dave Berkus. Five crucial components of the new firm are given a value of $0.5 million using this methodology. These elements include a strong concept, a working prototype, a top-notch management group, wise alliances, and early sales. The valuation of the company is then calculated by assigning a random value to each of these elements. $2 to $2,5 million is the potential startup value. But only pre-revenue firms are eligible for this strategy. It relies on approximations and is an overly simplistic valuation procedure.
- Scorecard method
A well-known angel investor named Bill Payne created the Scorecard Method to overcome the shortcomings of the Berkus Method. Using the value of a comparable business that has previously received funding, this technique calculates valuation. A number of variables are rated and given a relative weight, including the magnitude of the opportunity, the product or service, the technology, the stage of the company, the channels of sale, etc. After calculating the weighted average rating, the startup company’s worth is obtained by multiplying it by the typical pre-money valuation of a business that is comparable. By taking into account a large number of critical aspects, this technique improves upon the Berkus Method’s flaws.
- Discounted cash flow
One of the methods that is most often used to assess a firm that is still in the pre-revenue stage is the discounted cash flow approach, or DCF. In the pre-revenue stage, the majority of businesses’ value is mostly determined by their ability to generate revenues. An investor rates a startup using the DCF technique based on the projected cash flows the company is expected to produce in the future. Afterward, the investor (Venture Capitalists) determines the value of that cash flow using an anticipated rate of return on investment. The investor’s desired rate of return is applied to this number to adjust it for the time frame and hazards. In a nutshell, the DCF calculates the startup value by integrating time, risk, and money.
- Investment Technique
The venture capital approach, which the venture capital sector has adopted, is an additional way of valuing a business. By using the startup’s exit or terminal value, this approach seeks to value the business. The Venture Capital technique adds a multiple to these characteristics after taking into account turnover and other important P&L measures. The investor calculates an exit value using the projected returns. In general, the exit value is high since it does not account for hazards. In order to get the net present value, the previously determined exit value is subjected to a discount rate (reflective of the startup risks).
- Cost-to-Duplicate
The Cost-to-Duplicate approach, as its name implies, includes estimating the price to launch a second firm that is exactly like the one being appraised. It accounts for all costs paid throughout the product/service development process, including those related to technology, physical assets, research, and development, at their fair market value. This strategy is justified by the idea that an investor (Venture Capitalists) wouldn’t want to pay more than it would take to recreate it. This approach’s main drawback, however, is that it doesn’t take into account the startup’s ability to earn future earnings and a return on investment. Its failure to account for the value of intangible assets like brand value and goodwill, among other things, is another issue.
How to Summarize Risk Factors
Combining the Berkus technique with the Scorecard approach, the risk factor summation method builds on two earlier strategies. But it also considers every commercial risk that can have an impact on the startup’s rate of return on investment. Hazards associated with management, manufacturing, market competitiveness, company stage, capital requirements, litigation risk, technology risk, and others are some of the most often taken into account risks. The startup is given a projected value using one of the aforementioned techniques of valuation. The value of the original estimate is then increased or decreased depending on how well or poorly certain business risk categories performed. The startup’s final value is produced after applying the risk factor summing- Venture capitalists
One may reasonably get the conclusion that determining a startup’s value in its early stages is not an easy task. The most important thing is to get the estimate as near and accurate as possible despite the difficulties, limitations, and many affecting variables. If the value is estimated high, investors (Venture Capitalists) may have greater expectations, and if it is estimated low, owners may be more willing to offer investors a larger ownership stake. Thus, it is essential that the startup’s founders and prospective investors arrive at the most accurate value they can. Investors may determine a fair value by using the appropriate approach that accurately accounts for the startup concept, the market or sector to which it belongs, the risks involved, and the potential for growth of the firm.