How to value startup- Best methods(Detailed guide)

There are many business valuation methods to choose from. Some are more complex than others, and different methods can result in different valuations for the same underlying asset.  Choosing an appropriate business valuation method depends on several factors, including why you need a valuation. For example, when you're selling a business, you typically want to get a higher valuation. However, when buying a company you may prefer a more conservative valuation to avoid overpaying. It's also important to consider whether a business is asset-heavy or service-heavy. If a company has many assets, the net book value method can better capture their value. 

 

Investors also need to be aware of industry standards. Companies in specific sectors can usually be valued using a particular method or multiple that best reflects their value.   It is necessary to take into account the unique features of the technologies offered by the companies. A company looking for exciting but unproven technology might prefer a valuation methodology that captures future growth potential rather than current assets.  

 

 Ultimately, there is nothing wrong with using several valuation methods for the same company and looking at the average of all methods. Most traditional corporate finance valuation methods do not work well for early-stage companies. Discounted cash flow (DCF) is a suitable method for established companies that have a history of income and expenses. Assumptions about market growth rates, market shares, gross margins and other variables may be made to create scenarios that establish a valuation range. These assumptions cannot be accurately approximated for an early-stage company, making results questionable.  The price-to-earnings (P/E) ratio is not reasonable as most early-stage companies lose money. Price/Sales (P/S) can be used when a company has generated sales for a number of years.  —



Múltiples method

The most common approach used by investors. Recent acquisitions of similar ventures in the industry is utilised to set a base multiple. This results in the base market multiple, on the basis of which the initial valuation is made. However, not all startups have similar benchmarks and thus it can be very difficult for investors to evaluate the company based on this technique.  

The market multiples method is based on the theory that similar assets are sold at similar prices. Evaluate the company based on the recent acquisitions of similar companies in the market. This method of evaluating startups is most commonly used for those in their early stages with a very primary base. In this case, given the circumstances,  this is the best method to get the most realistic results.

 

For startups that have already generated some cash flow and can show profits, the multiples valuation method is one of the most widely used. Let's say your startup generates $250,000 in EBITDA. Depending on the industry you are in, your competition, your management team, and some other qualitative aspects, an investor might tell you that they value your company at, say, 5x, 10x, or 15x its current EBITDA. This is a powerful and simple valuation tool that allows investors to quickly estimate the value of a more mature startup.    

 

Cost to Duplicate

This method of valuation requires extensive due diligence but can be applied to both revenue-generating and profit-making businesses; The main objective of the duplication cost approach is to determine how much it would cost to duplicate the same business from scratch, including both physical assets (E.grams. physical assets) and intangible assets (e.g. brand equity).   The approach is a very realistic approach that challenges a startup's competitive advantages. If the cost of duplicating the startup is very low, then its value will be close to zero. In turn, if the business model is expensive and complex to replicate, the value of the startup increases as the difficulty increases.  

The rationale behind this form of valuation is that investors generally do not want to invest more than is required to duplicate the deal. This home appraisal method requires an extensive appraisal of the home's assets to determine fair market value. Many investors follow this method of evaluating startups in Mumbai and Gurugram. However, this method also has some disadvantages. This includes not including intangible assets in the cost of acquisition and also not considering the future revenue and growth potential of the company.     

 

Scorecard method  

Here you weigh five or seven key factors. Add them together to get an overall multiplier. This applies to a comparable market transaction.  

The six parameters are:

Technological differentiation  

Competitive intensity in the marketplace  

Marketing and sales strategy  

Customer feedback  

Team  

TAM

Disruptive potential 

 

A venture capital firm would assign weights to each of these factors and compare them to competitors. You would get the factors for each category by multiplying each category's weight by the startup's relative position.  

 

For example, if you thought that “team quality” should be weighted at 30% and your startup scored 125% in this area compared to your peers, the resulting factor would be 0.375 (30% x 125%). Add all the individual factors together to get a total factor. In our hypothetical example, let's say the total factor is 1.12.

This means that an investor would put up $3 million for a 30%  stake in your startup ($3 million / $10 million) x 100%.  If you think the investor is taking advantage of you, you should back out of the deal. Most investors are not unreasonable and will give due consideration to your position. However, you need to do your homework on why your startup is earning a higher multiple. The earlier the start-up phase, the less tried and tested the business model. 



Discounted Cash Flow 

The approach is based on the principle of projecting company’s future cash flows using an expected rate of return, also known as the “discount rate”. It forecasts future cash flows and then applies the discount rate to account for the associated risks. In general, higher discount rates apply to new companies because new companies carry higher risks. The only limitation of this emerging company valuation technique is that the valuation is highly dependent on the analyst's ability to accurately predict market conditions and make correct assumptions about future growth rates. This requires a high level of competence and experience because there is a lot at stake here.   The discounted cash flow method helps to determine an accurate return on investment and thus forecast the potential of the company. It further highlights the scale of growth, making it an accurate assessment method for startups. It is not the most widely used method for valuing new companies as it depends on cash flow assumptions but is more applicable to companies with historical cash flows.     

 

Berkus Approach  

This method was developed by Dave Berkus, an American angel investor and venture capitalist. It promotes the evaluation of a startup based on five key evaluation factors, including core value, technology, execution, strategic relationships in a core market, and resulting production and sales.

 

This process is based on five key aspects:  

Concept: The product concept must contain a certain level of creativity and innovation in order to stand out. The idea must have a fundamental value for an acceptable risk ratio. 

Prototype: Ensuring the prototype is healthy and fully functional helps lay the foundation for an easy launch and mitigates the risk of an initial failure. 

Management: Ultimately, it is the quality of leadership that determines a company's course. Good management inevitably has better planning and therefore better risk mitigation.

Connections – Business is all about Smart Grids as they can offer tremendous benefits for adoption and increase the chances of success. With established strategic relationships and alliances, a company has a greater chance of success. 

Adoption Plan – An adoption plan ensures a company has a better chance of taking off and meeting existing goals.   



Summarisation-of-risks approach  

This approach values ??a start-up based on the quantitative assessment of all company-related risks that affect the return on investment.  After considering all risk types and converting the “Sum of Risk Factors” to the initial final starting price, the final starting price is determined. Some types of business risk that are considered are managing risk, political risk, manufacturing risk, investment and capital accumulation risk, technology risk, market competition risk, and environmental risk. This technique is followed by various investment firms that conduct home appraisals in Gurgaon.    

 

The risk factors are listed below:  

  1. Management Risk   
  2. Business Stage   
  3. Political Risk  
  4. Supply Chain or Manufacturing Risk  
  5. Sales and Marketing Risk  
  6. Funding Risk  
  7. Competition Risk  
  8. Technology Risk   
  9. Litigation Risk   
  10. International Risk  
  11. Reputational Risk  
  12. Exit Value Risk   

 

The customer-based approach

With this method, the acquisition, retention and monetization of customers are taken into account when determining the company's value. Information on how well the company manages its customers is gathered and then applied in the standard discounted cash flow valuation method to determine the overall value of the startup. This customer-centric approach is a modern take on traditional startup valuation methods.        

 

Venture Capital Approach   

As the name suggests, this approach is the most preferred by VC’s for pre seed valuation. It also reflects the mindset of investors looking to exit a company in a few years.   There are two formulas you use to calculate your score:   Expected Return on Investment (ROI) = Final Value ÷ Post money Score  Post money Score = Final Value ÷ Expected ROI  

 

First, you calculate the Final Value of your startup value or the expected selling price after the VC firm has invested. You can find this out by using estimated sales multiples for your industry or price-to-earnings ratio.   Determine the expected ROI, e.g. B. 10x, and plug it all together to find your after-the-money value. From there, subtract the investment amount you are requesting to get your pre-money score.  The formula is:   Pre-Money Valuation = Post-Money Valuation – Invested Capital

 

Comparable method  

This approach uses benchmark data and numbers from other similar transactions to estimate the value of a startup appreciate. It can be used for revenue-generating businesses but is more commonly used for revenue or profit-generating businesses. Let's say an app similar to the one the startup is developing was recently valued at $5,000,000 by a venture capital firm and the app had 100,000 subscribers/active users. This means the company was valued at $50 per user. 

 

An investor could use this benchmark to evaluate a startup with a similar application. It is one of the most conventional best practices to provide investors with realistic scenarios and values. Because it is based on precedent, it is the most popular method. This method takes information about how many other similar startups have been acquired in recent years and uses it as a precedent to arrive at a valuation. The comparable transactions method is commonly used to compare and analyze two similar companies.     

 

CONCLUSION  

As a startup founder, you need a valuation estimate that you can justify to potential investors and trust for other reasons. An accurate assessment will help you design your long-term fundraising strategy and keep track of your funding requests. There are endless techniques to determine the value of a company, but it depends on the analytical skills of the investor which technique should be used in which situation and in which type of business model. The best technique is one that takes into account both financial and human elements and can determine the value that comes closest to an exact value of the company.   No single startup valuation method is always accurate. You will most likely work with multiple methods and combine techniques to find a fair value. Don't forget to use the company's databases to ensure you are on the right scale.

 

Or you could let us do it for you, here.

Zeal Karwa

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