Startup Valuation Methods

 Startup Valuation Methods

To do the valuation of a listed company is a comparably easy task to do, but when we talk about startup it is really very tough due to some reasons like lack of financial history, availability of financial reports, no comparable and many more and finding the right method to value a particular startup is not easy either and sometimes we don’t know how many methods do we have in the market available to value this magical box, as I often refer the start-up “a box” where you add things to increase value like you add kick-ass management, add a sophisticated revenue model and many other things its value increases.

But it’s a very expensive box, so you distribute it in parts which refer to as equity, where the investors buy a part of your box you give him/her a percentage of the ownership as equity. Why you distribute this box because you need money to add more kick-ass things to make it more expensive and for an investor, this works like you put money and it multiplies it 2x, 3x or maybe 10x depends on the quality of the box after some years. Amazing…isn’t it??? But with great returns, comes great risk and this box also contains the risk of losing all money as money doesn’t come so easily, one who takes risk earns a high return as they are very correlated with each other.

To value this magical box is the most important risk to check its real worth because you cannot put any amount in exchange for any percentage equity. So in this article, I will summarize and give a brief about the type of valuation methods we have with us in the market. I will also write a detailed article on how to do a valuation of this box.

Berkus Method

Designed by the renowned author and a super angel investor, Mr. Dave Berkus. If we believe that the revenue in the fifth year of business can reach up to $20 mn, then we can assess the startup with the below 5 parameters by assigning a max of $500k to each but not exceeding the pre-money value of more than $2 mn. This method is basically meant for the pre-revenue startup.

Scorecard Method

This is also the same as the above method, however, the only exception here is that we assign weights based on their impact on the overall success of the startup. First, we have to determine the approximate average of pre-money valuation of the target segment companies in which the startup you are valuing doing the business and then multiply that pre-money valuation with the factor which we have calculated with the help of the below sheet to come up with the value to your startup.

Risk Factor Summation

It is a more elaborated version of the above two, where you determine an initial value for your company by taking the average value for the similar ones in your domain and then you adjust the pre-determined value with respect to the 12 risk factors inherent to startup.

The risk is modeled like +$500k for very low risk and -$500k for very high risk. They all should be in a multiple $250k.

Book Value

Forget about how magnificent your startup is, see how much they have in their books as in how much assets they have in the form of tangible assets. As commented by many of the renowned angel investors this method is not particularly relevant for the startup as they have a maximum of their assets in the form of intangible like user base, software, etc.

Discounted Cash flow

As we know that the startup will bring some amount of cash flow because of its operation. So, by the traditional method, we can say that the present value, using a discount rate, of all the future cash flows over the next years sums up to the current value of the startup.

In this method, we have project cash flows by using a growth rate up to n year, and then by the principle of going concern we have to come up with a terminal value or else we can consider an exit amount after n year.

It is a very technical method as one has to estimate cash flow, growth rate, discount rate, exit multiple/value (if not using the terminal value approach). So, for a detailed understanding, we will be writing a dedicated article on this method in the subsequent post.

Comparable transactions

Find other comparable firms like yours by considering parameters that are specific to your industry including, but not limited to, EBITDA, the patent filed, weekly active users or WAU, gross margin, sales. Benchmark the comparable firms and then find the mean and median of the key multiples like EV/Sales, EV/EBITDA, EBITDA margins, etc.

Venture capital

The value from a viewpoint of an investor where a venture capitalist looking for a specific multiple in the exit or can say return as they think that your venture can be sold for x amount in n years. So, based on these two assumptions a VC can determine the maximum price he/she is going to put into in exchange for a percentage of ownership (which is negotiable).

For example, an investor first set a target ROI, let say, 20x, and then anticipate an exit value suppose $1 bn. Now, he/she divides the exit value by the multiple/ROI to get a post-money valuation and then subtracts the amount willing to invest, to get the pre-money valuation. But what if the investors anticipate the need for subsequent investment? So for this, you just have to bring down the pore-money valuation by the estimated level of dilution from later investors like if we anticipate that 30% dilution will happen then reduce the value by of this round by 30% to adjust the next round dilution. We can use this method for estimating pre-revenue startups.

Liquidation Value

As implied by its name, the value you gave to a company when it is going out of business. All the tangible assets like Inventory, buildings, land, etc. will be counted for liquidation. In a more sophisticated way, the liquidation value is the sum of the scrap value of all the tangible assets of the company. All the intangible assets will become worthless in this process. It is useful for an investor to evaluate the risk of the investment.

First Chicago

Last but not least the First Chicago Method, tells you the answer to a specific situation which is what if your startup has a chance of becoming a Unicorn. For this, we have to make three scenarios Worst case, the normal case, and the best case by the use DCF method and then assign a probability to each scenario to come up with the final valuation.

Founders’ unfiltered discussion EP1 – Hamza Sayed, Founder – The Comic Book Store – Youtube, Spotify

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thevcstories

https://thevcstories.com

We manifest the entrepreneurial and startup ecosystem for enthusiastic entrepreneurs by helping them build their entrepreneurial skills and encouraging them in job creation rather than finding ones. These episodes aim to provide much-needed guidance & motivation among the youth and bridge the knowledge gap.

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