How to Value Startup - 9 Real World Valuation Method used by Investors

How to Value Startup - 9 Real World Method used by Venture Capitalist and Angel Investors

How to Value Startup - 9 Real World Valuation Method used by Investors

Startup valuations shed light on a company's capacity to employ fresh funding to expand, satisfy customers and investors, and reach the next goal. Today, there are hundreds of startups with unicorn valuations, or those valued at $1 billion or more. Today, there are "hectocorns," or startups valued at over $100 billion, as well as "decacorns," or startups valued at $10 billion.

These calculations are impressive, but they're not as accurate as you may assume. A startup's valuation may take into account things like the skill set of your team, the product, the assets, the business strategy, the total addressable market, the performance of its competitors, the market potential, goodwill, and more.

You can utilise specific economic data as a starting point if you have actual revenues. But when it comes to fundraising, the value of your company ultimately depends on what you and your investors think it is worth. Additionally, the majority of venture capital firms and angel investors utilise a variety of methods to determine a company's pre-money valuation, or how much it is worth before they invest.

It is true to claim that determining a startup's value involves both art and science. It will be beneficial for you to comprehend the many business valuation techniques, regardless of whether you are in the pre-seed stage or are only giving stock options to your staff. We'll cover eight techniques in this article to help you assess your startup and get ready for potential fundraising discussions.

Various types of Valuation Method to Value Startups

Although there will always be some element of guesswork involved in value calculations, you can prepare some useful materials in advance. A balance sheet and other financial documents are crucial. Be prepared to evaluate your team's abilities and experience and pinpoint any strengths and limitations.

You can check online indices and open business reports, or you can use databases like AngelList or Crunchbase to directly compare your worth to that of similar companies.

By their very nature, appraisals will vary between regions, sectors, and time periods. For instance, a Indian proptech business formed in 2020 shouldn't be judged by the success of a Silicon Valley property technology startup founded in 2009. Additionally, a B2B company's inputs could be vastly different from a B2C company's.

1. Comparable Transactions Method

Because it is based on precedent, the Comparable Transactions Method is one of the most widely used strategies for valuing startups. You're responding to the question, "How much were startups similar to mine valued for?"

Consider the hypothetical shipping startup Dotco being bought out for $24 million with 700,000 people used its website and mobile app. That comes to about $34 per user. Let's say 120,000 people utilise your shipping startup so this results in a $4 million valuation for your startup.

Additionally, you can locate revenue multiples for comparable businesses in your industry. It can be typical for SaaS businesses in your industry to create 5x to 7x the net sales from the prior year.

Any comparison model must account for ratios or multipliers for any significant differences between the two startup. For instance, you could wish to utilise a multiplier at the lower end of the spectrum, such as 5x (or lower) in our previous example, if another SaaS company has proprietary technology while you do not.

2. Scorecard Valuation Method

For startups, another choice is the Scorecard Method. It also functions by contrasting your startup with others that have received funding but with additional requirements. You start by determining the typical pre-money valuation of similar companies.

Then, you'll think about how your company compares to the following characteristics.

  1. Strength of the group: 0% to 30%
  2. Opportunity size: 0 to 25 %
  3. Product or service: 0 to 15%
  4. Environment of competition: 0–10%
  5. Partnerships, marketing, and sales channels: 0–10%
  6. A 0–5% increase in investment is required.
  7. 0 to 5% other

Then you will assign a comparison percentage to each quality. In essence, when compared to your rivals, you can be on par (100 percent), below average (100 percent), or above average (>100 percent) for each quality.

Find the total of all the components by doing this for each starting quality. Finally, to determine your pre-revenue valuation, double that amount by the typical valuation in your industry.

3. 5x Your Raise Method

The majority of investors desire to see their money valued at 20–25 percent of the post-money valuation. This results in a valuation of 4X–5X depending on the investment.

A $500K investment plus $1.5M in pre-money, for instance, results in a $2M post-money valuation utilising the 4X raising $500K method. A $500K investment + $2M in pre-money in a different example employing 5X raising $500K results in a $2.5M post-money valuation.

Your pre-money ranges from $1.5M to $2M using this strategy. This offers you a rough idea of how much your raise will be worth.

4. Cost-to-Duplicate Method

The name of this technique contains the secret. Calculating the cost to replicate your startup elsewhere after deducting any intangible assets, such as your brand or goodwill. The fair market value of your tangible assets is simply added together. You can also include costs for product prototypes, patents, and research & development.

One significant problem is that this approach automatically undervalues a company, especially if it is making money. You might have to discount factors that are extremely important, like your startup's customer involvement, when determining its valuation.

5. Risk Factor Summation Method

This method of valuing your startup is more comprehensive. Start by performing an initial value using one of the various techniques described above. Then, based on hazards impacting your company, increase or lower the monetary value by multiples of $250,000.

Low-risk components receive a double-plus grade (++), which raises your valuation by $500,000. The grade for high-risk components is a double-minus (--), and you deduct $500,000.

For instance, you can grade your online custom clothing store favourably but only add $250,000 if there is a slight but low risk of competition.

The following are the 12 typical risk categories:

  • Stage of the business's management
  • Political and legal risk
  • Risk in manufacturing
  • Risk in sales and marketing
  • Funding/Raising Capital Risk
  • Risk of competition
  • Technology hazard
  • Risk of litigation
  • Risk on a global scale
  • Risk to reputation
  • Potentially prosperous exit

The most challenging part of this strategy is determining an impartial point of comparison to evaluate each component. It could be helpful to start with comparable approaches, such as the Scorecard Method or the Comparable Transactions Approach.

6. Discounted Cash Flow (DCF) Method

The Discounted Cash Flow (DCF) Method is another tool that may be used to value businesses. To employ this technique, you might need to collaborate closely with a market analyst or an investor.

You start with your anticipated future cash flows and add a discount rate, also known as the anticipated rate of return on investment, to them (ROI). Generally speaking, the riskier the investment, and the better your growth rate needs to be, the higher the discount rate.

The reasoning for this is because investing in startups has a higher risk than investing in companies that are already up and running and generating steady profits.

7. Comparison Valuation Method

Founders and investors frequently look at startup valuation by comparing it to valuation in recent and comparable M&A deals or venture investments. Given the dearth of alternatives, I believe this is a reasonable approach to view startup valuation.

Of course, this form of valuation has a drawback in that a startup's valuation can drastically alter depending on the state of the market, so be sure you know which approach to valuation is best for your startup business. For instance, one business type might be popular compared to another, making a large portion of startup valuation dependent to investor whims and trends.

8. The Venture Capital Method

This approach, which is used frequently by venture capital firms as its name implies, is one more choice to take into account if you require a pre-revenue value. It also reflects the perspective of investors who want to leave a company in a few years.

You'll work toward your valuation using two formulas:

a. Expected Return on Investment (ROI) = Post-Money Valuation Terminal Value
b. Terminal Value = Post-Money Valuation – Expected ROI

You should first determine your startup's terminal value, or the anticipated selling price following the VC firm's investment. You can determine this using the price-to-earnings ratio or the expected revenue multiples for your industry.

Input everything and a predetermined ROI, such as 10x, to arrive at your post-money valuation. The investment amount you are requesting is then subtracted to obtain your pre-money valuation.

9. Gross Profit x Multiple Competitor Analysis

Gross profit multiplied by a multiple based on industry, offering, and sales growth is the method of valuation for startups. Because they continually reinvest profits back into the company, organisations that aren't profit optimised can nevertheless be fairly valued using gross profit as a measure of growth, company health, and market penetration.

So how do you determine the valuation of your Startup?

As you can see, different people arrive at their startup valuation using various methodologies. The differences, meanwhile, are very negligible—a little bit of a different computation here, a change in perspective there. However, a lot of them evaluate both the financial and human aspects when determining the "worth" of a startup.

So keep in mind: You must take into account both human and financial factors. However, even when you are spending hours and hours on cap tables and computations to value a startup, make sure you never lose sight of the human being. Because your startup's employees are what really make it what it is.

As the founder of a startup, you must a valuation estimate that you can both believe and defend to potential investors. Your long-term capital raising strategy can be created and your funding requests can be kept in perspective with the aid of a precise appraisal.

No single startup valuation technique is consistently correct. To determine a fair value, you'll probably use a variety of approaches and combine strategies. To be sure you're on the right track, don't forget to use company databases.

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