The growth of entrepreneurship has given rise to one of the most often used terminologies in business and finance history:’startups.’ A startup is a small firm that started with an idea and is currently searching for funding to expand and develop.
Startups, like newborns, need funding to grow, test ideas and build a team. A firm must be appraised to attract funds; therefore, knowing how startup valuation methodologies operate is critical for every serious and dedicated entrepreneur.
Why is it vital to assess a startup’s worth?
A company can only go so far if it has the funding to properly develop its core concept or idea. A company without money is doomed to fail; thus, acquiring financing for your firm and expanding the technical side of the business is one of the most critical activities you may find yourself immersed in.
You’ll need money for marketing, office space, prototype development, staffing, inventory, and a slew of other expenses, and determining the value of your business is the only way you’ll be able to propose your concept to an investor who’ll ask, “How much is it worth?” There are various approaches for valuing a company to select from.
What are the most often used techniques of valuation?
Thousands of valuation methodologies are available to venture companies and individual investors, ranging from the simplest to the most complicated, which incorporate various qualitative factors and statistical analysis. The following are some of the most prevalent strategies for valuing a startup:
To establish pre-money and post-money values, a startup valuation approach that uses an anticipated terminal value for the business and an expected return from the investor (typically specified as 10X, 8X, and so on) is used.
Pre-Money Valuation = Post Money Valuation — Invested Capital
The terminal value divided by the projected return is the Post-Money Valuation.
Let’s imagine an investor sees your firm as having a $1,000,000 terminal value and is looking for a 20X return on his $10,000 investment. Your Post-Money value would be $50,000 in this situation. And the Pre-Money Valuation would be as follows:
Pre-Money = $50,000 — $10,000 = $40,000
Berkus Method (Scorecard Method)
Method of Venture Capital
A simple approach for valuing pre-revenue enterprises based on five major factors (hence the name scoreboard valuation method), with each factor receiving a certain amount of money.
To be regarded as a qualitative aspect. Value
Prototype of a Good Idea
Management of the highest caliber Strategic Relationships within the Team
Each product launch or sale generated $500,000 in revenue.
The startup’s worth should increase by $500,000.00 for each complete feature it has. However, depending on how each part is developed, the investor may decide to cut the item’s worth to $400,000 or $250,000 as the ultimate value.
The Cost of Duplicating an Approach
The cost of to duplicate valuation method necessitates extensive due diligence, but it can be applied to both pre-revenue and profit-generating businesses. The cost to duplicate approach’s main goal is to determine how much it would cost to duplicate the same business from scratch, including tangible (e.g., physical assets) and intangible (E.g., brand value).
The cost-to-replicate method is a highly practical one that questions a startup’s competitive advantages. If the cost of reproducing a company is minimal, the startup’s value will be negligible. As a result, if replicating the business model is expensive and difficult, the startup’s value will rise as the complexity rises.
Discounted Cash Flow Model (DCF)
Financial analysts, venture capital companies, and angel investors use valuation methodologies to assess the worth of a company by projecting future cash flows and discounting them at a given discount rate to arrive at the present value. The resultant value for the startup will be the total of these discounted cash flows. This approach is not generally used to assess startups since it depends largely on cash flow assumptions that need some past data, but it is more appropriate for those having historical cash flow.
Method of Comparables
To assess the worth of a startup, this method uses referential information and data from previous comparable operations. It may be used for pre-revenue businesses, although it’s more frequent for businesses that generate income or profit. Let’s assume a venture capital company recently valued a comparable app to the one produced by the startup at $5,000,000, and the app had 100,000 active subscribers/users. This indicates that each user was worth $50 to the firm. An investor may use this benchmark to determine the worth of a firm with a comparable app.
Method of Multiples Valuation
The Valuation by Multiples approach is one of the most often used for businesses that have already produced some cash flow and are profitable. Let’s imagine your company generates a $250,000 EBITDA. An investor may value your firm at 5X, 10X, or 15X your current EBITDA, depending on your industry, competitors, management team, and other qualitative factors. Investors use this strong and easy valuation tool to swiftly evaluate the worth of a more mature company.
The Scorecard Model, the Book Value Method, and the First Chicago Method are three more prominent valuation methods.
Choosing the most appropriate strategy for your stage
From the time an idea is conceived until the point at which the firm has evolved into a fully operating organization, startups go through many phases. These startup valuation models are more suited to some phases than others, so you’ll need to figure out which stage you’re in before choosing the right strategy. Here’s a rundown of the four phases that most companies go through:
For each startup, this is the first stage. There is generally no income, no assets, no staff, and no company at this phase. All you need is an idea and the desire to take action. The Berkus Method or the Venture Capital Valuation Method may be the best suggested for you among other startup valuation methodologies.
Round A Stage
Your business is now able to come on the go. You most likely have a beta product or a prototype or made some sales. You may now use more technical approaches like the Cost-to-Duplicate method or, yes, the VC Method once again. Remember that what you’ve done so far may not indicate what’s to come, so don’t undervalue your company by treating current data as if they were your startup’s final success indicator.
Round B Stage
Money is required at this time to expand and continue expanding. The company strategy has been established (to some degree), and you can estimate your revenue-generation potential. You may now use various company valuation algorithms largely reliant on financial data to arrive at a figure. The DCF Model, as well as the Valuation by Multiples Model, are two of these methodologies.
Several further advanced phases are closer to an IPO, but since getting to those stages requires significant advance and advising, you may not even need this guide; investment bankers and advisors will most likely do a superb job valuing the firm.
What is the most amount I can anticipate raising at each stage?
That relies on various variables used to evaluate your startup’s prospects, including your ability to craft a convincing presentation deck and the soundness of your startup’s business strategy.
Nonetheless, based on the predicted business valuation stage, you may expect to raise a sum similar to the following:
· Seed Stage: From $250,000 to $2,000,000
· Round A Stage: From $2,000,000 to $15,000,000
· Round B Stage: From $15,000,000 to $50,000,000
When compared to more standard discounted cash flow models and those utilized for an Initial Public Offering, startup valuation approaches are just approximations.
There is no ideal method to evaluate a new firm with almost no assets. Nonetheless, the methodologies and facts described in this article may offer you a clear picture of what you can anticipate from possible investors based on your startup’s value and what you should ask for.