9 Startup Valuation Methods: Convert Your Business into Account
An economical procedure for calculating the value of any startup is often called startup valuation. Startup valuation methods are significant for the startups, which are in their pre-revenue stage. Every startup company needs a large quantity of cash at its initial step.
Eventually, all entrepreneurs must calculate the valuation of their company, including the services, product, customer value, and also the idea itself. The companies which are in their primary funding stage, the methods of startup company valuation can be a tricky attempt for them.
Generally, they have many things to consider, such as marketing management, marketing team, market risk, trendy product demands. Here is the important thing that ought to be kept in mind,
“After evaluating everything that is worth your management of the company, even with the foremost effective formula of valuation, the most effective thing we are able to hope is that the entire valuation number is simply an estimate.”
New business people struggled much to calculate the valuation for their startup in the early stage. There are so many startup valuation methods by some financial analysts. That helps us to estimate the exact value of our startup.
The Necessity Of Startup Valuation
There are some companies that are publicly listed, and they have steady revenue earnings. For them, it is simple to calculate their valuation. On the other hand, the companies that are in their pre-revenue stage it is challenging for them to figure out the actual amount.
When you are not able to make an exact figure that is worth your startup, then you also find it difficult to manage an investor for your firm.
From a textbook knowledge we believe that valuation is art and science both. Research the actual assessment of any comparable company and construct your own revenue based on it, which represents science.
Making your team strong and promoting trendy items is an example of art. However, if you want financial help from third-party investors, the main task for you is to estimate the valuation of your firm.
Genres of Startup Valuation Methods
There are various methods on how you could estimate the value of your startups. We are going to address some leading strategies that can develop your idea about valuation.
So, we will discuss 9 methods of startup valuation that can help all entrepreneurs out there.
Venture Capital Method
This method normally depends on the investor’s viewpoint. Venture capitalists invest in the companies that are in their initial stage in exchange for equity or a 20x profit return. To estimate the pre-money and post-money valuation the venture capital method is,
Pre-money valuation= post-money valuation – Invested Capital
Consider an example; there is a startup company named Sunrise and investors think that this company could be sold for $100 million in eight years. So they invested $1 million to Sunrise in exchange for 20x target ROI. Now, the post-money valuation of Sunrise would be ($100 / $20)million = $5 million. So, the pre-money valuation will be,
Pre-money valuation= $5 million – $1 million = $4 million
This process is typically used for pre-revenue and post-revenue startups. So applying this method, you can easily estimate your firm’s pre-money valuation.
First Chicago Method
This method is known by the name of the late First Chicago Bank. Here we have three types of scenarios in this process. They are the Worst case scenario, Normal case scenario, and Best case scenario. Now explaining the method,
As an example, we assume that the best scenario is $400M and normal and Worst scenario is $100M and $70M. Now simultaneously, the probability is 10%, 80%, and 30%. So the overall valuation will be (400*.10 + 100*.80 + 70*.30) = $141M.
Basically, the First Chicago method is the average number of all the cases. This method is applicable to post-revenue startup companies.
Risk Factor Summation Strategy
In this process, a business person should estimate the initial value of his/her company. After determining the cost, the next step is to adjust the amount of all risks associated with the business and can affect the return on investment(ROI).
Sometimes the initial fund can be positive or negative, but in a further case, we have to add the value of business risks. When we include the value, the principal balance can be increased or decreased. Here are 10 types of business risks that we are mentioning,
- Competition risk.
- Funding or capital raising risk.
- International risk.
- Litigation Risk.
- Manufacturing risk.
- Management risk.
- Potential lucrative exit.
- Reputation risk.
- Sales and marketing risk.
- Technology Risk.
However, we use a risk summation method for pre-revenue based startups.
This method is discovered by American businessman and angel investor Dave Berkus. From this process, it is easy to calculate your valuation. At first, you have to believe in your business that it could reach a certain reasonable level of profit. After that, the leading 5 key criteria will be added with your principal balance, and that can raise your balance. Now the 5 key success factor is,
So we can use this method for pre-revenue based companies, and this will give you a solid idea of how much your company is worth. The important thing is that when you are applying this method, the maximum range of pre-valuation will be $2M always.
Comparable Transaction Approach
The first thing is that you have to find a company that provides the same product and service as like as your business. When you are able to find one like that, then calculate your pre-valuation or post valuation on the basis of it. When you are finding a similar company like yours, you should consider some requirements that match your firm. Such as HR headcounts, number of outlets, patent field, number of weekly active customers, etc.
So that is how you can estimate your valuation using a comparable transaction method. We use this method both for pre-revenue and post-revenue startups.
Book Value Method
In this method, first, you should check how much value one pound cardboard contains. These assets usually help a startup to calculate their worth value. This process always describes the net worth of any company, such as tangible assets of the company, the hard parts.
Sometimes people find book value methods irrelevant because most of the companies out there focused on intangible assets. Example: R&D for a biotech firm, user base & software development for a web startup.
Discount Cash Flow Method
DCF method depends on any startup’s future cash flow movement. When we invest the money, we get a rate return based on our investment, and that is known as the discount rate. We usually calculate the discount rate based on how much the future cash flow is worth.
Startups generally struggled for funding at their primary stage, so investing in them brings high risk also. More clearly we can say if your company works well, it will bring a certain level of profit of money each year. So it is obvious that the current value of a business is the summation of all the future cash flows over the next years. That is the main strategy behind the DFC method.
Market Multiple Approach
One of the most popular startup business valuation methods is the market multiple processes. This method works as the most multiples generally do. At first, we should find a startup in which a recent purchase product number is similar to the startup that we are taken into consideration.
After that, we have to determine a base multiple on the basis of the current acquisition value. So using this base multiple, we can easily estimate the valuation of our startup.
The cost-to-duplicate method is an estimation of all costs and expenses associated with the company and the development of its product, including the purchase of its physical assets. All these expenses are estimated to determine the fair market value of the startup. However, there are two drawbacks of the cost-to-duplicate method, and they are,
- Do not consider the company’s future potential and future sales growth.
- Do not consider the company’s intangible asset along with its physical asset. However, the argument that comes here is an intangible asset works very significantly, and it brings a lot of offers for any startup even at their initial stage.
Summary of Startup Valuation Methods
Incredible job! If you made it this far. Now you know the most necessary 9 methods that can help you to calculate the valuation of your startup. Valuation is one of the best starting points when you are fundraising for your company.
Transforming your business into money genuinely helps you to be confident and contribute to objectify the primary negotiation. In the end, we can say that the points will remain theoretical if you do not apply them in your practical life.
So, try them out and make these valuation methods for startups, easier to implement, don’t do mistakes!
Afrida Nower Mowmi
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