Whether you are on the founder team or an investor, evaluating and valuing the startup is one of the most crucial and challenging activities to perform. Valuations may performed for various reasons, but regardless of the purpose, a valuation is typically performed using one or more industry-standard methodologies.
Purpose of Valuation
Some of the most common reasons to value a company include the following:
- Determination of funding round pricing
- Stock compensation
- Bank reporting
- Financial reporting
- Tax reporting
- Legal disputes
When determining the value of a company, one must consider the value drivers of the company and of the industry it operates within. While the financial projections and other relevant KPIs are important for evaluating the startup, there are many other qualitative factors that will impact a company’s valuation.
Company-specific factors include:
- intellectual property
- unit economics
- potential need for future capital
Market or industry factors include:
- market size
- competitive landscape
- regulatory landscape
- market / industry growth prospects
- Market pricing for similar companies (“comps”) recent funding rounds
- Public comps’ KPIs / metrics and other comparable market data
Startup Valuation Approaches
There are many different ways to value a company, but the key is understanding which approach makes sense for your company and for the purpose of the valuation. The approach or approaches you choose will also depend on what information is known to you today and what assumptions will need to be made.
Some of the more common valuation approaches for startups include the market approach, income approach and Berkus method.
The market approach involves using available date from comparable transactions or comparable companies as a basis of comparison for the startup. In this approach you will blend your company’s financial performance (and/or projections) with market data, such as trading multiples to infer the value of your company. This approach is commonly used when the company has financial performance data to compare (i.e., sales, gross profit, EBITDA) and is reasonably comparable to a set of public companies.
The income approach involves using a discounted cash flow model to determine the net present value, or intrinsic value, of the company. This approach requires the use of cash flow projections, assumed growth rates, assumed exit scenarios and a discount rate in order to compute the fair value of the business. The income approach is not typically the primary valuation methodology used to value startups given the challenges involved with projecting future performance.
In many cases, a startup that requires a valuation may have little or no revenue. It is hard to use market multiples or discounted cash flows to value a company that has no financial history or ability to reasonably project future cash flows. The Berkus method may be used to determine company value by ascribing a maximum value if certain scenarios are true / exist.
In simple terms, for each condition’s existence below a maximum value would be added to the total value of the company:
- Sound idea
- quality management team
- strategic relationships
- product rollout or sales
Other Valuation Methods and Resources
While the valuation approaches listed above may be considered the most common, there are other approaches the entrepreneur can consider. A collection of resources and templates can be found below: