How Does Startup Valuation Work?


As an investor, I often encounter the CEOs of startups who either undervalue themselves or go for a much higher number than they should. Valuing a startup is a crucial process, especially when you are raising funds or seeking investments. You might have a great idea that will solve the customer’s problems most effectively. You probably have the MVP for that. When you go to investors for additional funding, you must first determine the valuation of your startup.

How to Value My Startup
As a budding entrepreneur, this might be the first question that comes to mind. You've probably heard that the valuation of a startup is more of an art than a science. What is it? When a startup is embarking on the market, generally, they don’t have any financial history. Maybe the company is newly opened. Maybe the company has yet to see any solid profit in the market. Because startups frequently create their own markets, finding any precedent information will be impossible.

But even in this situation, the valuation of the startup is necessary. So, it often goes beyond the value of the components of the company. Resources, technology, intellectual property, financial assets, brands all these are taken into account while valuing the company. 

Factors that Might Affect Your Startup Valuation

So, if you want your startup to be evaluated correctly, there are a few factors that you should consider. These factors are often very important to decide whether a startup is even worthy of investing in or not. Take a look. 

  • A Strong Customer Base
    Irrespective of the market you are catering to, you need to have a loyal customer base the people who will purchase your product and add to your revenue. Even if you are a one-of-a-kind company with no existing customer base as of now, you should have a plan in place to attract these customers. After all, if there is no promise of revenue, the company is not worth investing in.
  • Growth Potential
    You bring a new idea to the table, which is excellent. But does it have the potential to grow and scale? When investors are looking at your business plan, they are looking for ways in which their money is going to get multiplied. If your startup does not have a plan to win the race with its competitors, then no money will come your way. You must have a plan that includes achievable long and short-term goals and a timeline. The investors will want to know where you see your company in the next 12 months, 5 years, or 10 years. You should have answers to these questions. 
  • Profit
    This one goes without saying. Profit is what you and your investors are looking for. Without profit, what is the point of your business and its ideas? In the end, you want to make a profit from what you do, and your investors want the same. Having profit or the potential for it will not only give you the right value for the company, but it will also give you an exit strategy too.
  • Brand Value
    Brand value is a great factor to get traction with the target audience. For a startup, it is important to make their presence felt in an already crowded market. You must create a brand identity and meaningful connections with your customers. This will be considered critical for your company's value. 

What are the Different Methods of Company Valuation?
Whether you are seeing any profit or you are issuing stock options to your employees, ultimately, the value of your company is what you and your investors agree on. Here, I am going to tell you about four popular methods that can be used to determine the value of your startup.

  • The Berkus Method
    Venture capitalist Dave Berkus created this method first, and he did it specifically for the pre-revenue companies, the ones that have yet to make a sale. This is a simple formula that assigns dollar amounts to the company’s five success metrics. In this method, the market value is not taken into account. This is a very useful, uncomplicated tool for the valuation of your company.
  • Comparable Transaction Method
    This is a very popular method that helps you find out how much similar companies like yours were acquired for. In this case, you have to keep in mind that SaaS companies can make five or seven times more revenue than you are currently making. Also, you have to use ratios and comparisons to account for the probable drastic events that can affect the value of your company.
  • Scorecard Valuation Method

        Created by Bill Payne, this method is used for pre-revenue startups. Your startup will be compared with the other companies that have received investments. Then you will have to calculate while keeping the following qualities in mind:       

  • Strength of the team
  • The size of the opportunity
  • Product or service
  • Need for additional investment
  • Marketing, sales channels, and partnership
  • Competitive environment
  • Others

        You will assign a percentage to each of these factors depending on the expertise or excellence of that particular department.

  • Cost to Duplicate Approach
    This is exactly what the name means. You have to find out how much it will cost to set up your company elsewhere. In this case, you have to strike out intangible assets like brand influence and goodwill. You will have to calculate the fair market value of the physical assets, the cost of development, operation, prototype, product, patent, and so on. This is a more effective method for companies that are already making profits. 

    To conclude, the valuation of a startup is crucial when you are raising money from investors. This will determine the future operation of the company and how successful it can become. The valuation should be precise and accurate, as this will determine whether the investors see any value in your business or not. In my opinion, there is no single method that can claim ultimate accuracy. You have to combine more than one method to get the value of the company. While you are doing this, take advantage of the company database and ensure you are keeping your investors’ decisions in mind. 
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