Startup valuation methods are the ways in which a startup business owner can work out the value of their company.
These methods are important because more often than not startups are at a pre-revenue stage in their life-span so there aren’t any hard facts or revenue figures to base the value of the business on. Because startups typically go through a series of ‘funding stages’ their valuations can differ after each round of funding, and typically they’ll want to show growth between each round.
There are many different methods used in deciding on a startup’s valuation, and while all of them differ in some way, they are all good to use.
1. Venture Capital Method
The Venture Capital Method (VC Method) is one of the methods for showing the pre-money valuation of pre-revenue startups. Formulas: – Return on Investment (ROI) = Terminal Value ÷ Post-money Valuation – Post-money Valuation = Terminal Value ÷ Anticipated ROI Terminal value is the startup’s anticipated selling price in the future or its expected IPO price, estimated by using reasonable expectations for revenues in the year of sale and estimating earnings.
2. Berkus Method
The Berkus Method assigns a range of values to the progress startup business owners have made in their attempts to get the startup off of the ground.
3. Scorecard Valuation Method
The Scorecard Valuation Method uses the average pre-money valuation of other seed/startup businesses in the area and then judges the startup that needs valuing against them using a scorecard in order to get an accurate valuation. The comparison is done using factors such as market size, revenue, growth prospects, etc.
4. Risk Factor Summation Method
The Risk Factor Summation Method compares 12 elements of the target startup to what could be expected in a fundable and possibly profitable seed/startup using the same average pre-money valuation of pre-revenue startups in the area as the Scorecard method.
The 12 elements are,
Management
Stage of the business
Legislation/Political risk
Manufacturing risk
Sales and marketing risk
Funding/capital raising risk
Competition risk
Technology risk
Litigation risk
International risk
Reputation risk
Potential lucrative exit
Each element is assessed as follows:
+2 – very positive for growing the company and executing a wonderful exit
+1 – positive
0 – neutral
-1 – negative for growing the company and executing a wonderful exit
-2 – very negative
5. Cost-to-Duplicate Method
This approach involves looking at the hard assets of a startup and working out how much it would cost to replicate the same startup business somewhere else. The idea is that an investor wouldn’t invest more than it would cost to duplicate the business.
The big problem with this method is that it doesn’t include the future potential of the startup or intangible assets like brand value, reputation, or the hotness of the market.
With this in mind, the cash-to-duplicate method is often used as a lowball estimate of company value
6. Discounted Cash Flow (DCF) Method
This method involves predicting how much cash flow the company will produce, and then calculating how much that cash flow is worth against an expected rate of investment return.
A higher discount rate is then applied to startups to show the high risk that the company will fail as it’s just starting out. This method relies on a market analyst’s ability to make good assumptions about long-term growth which for many startups becomes a guessing game after a couple of years.
7. Valuation by Stage
The valuation by stage method is often used by angel investors and venture capital firms to come up with a quick range of startup valuation.
This method uses the various stages of funding to decide how much risk is still present with investing in a startup. The further along a business is along the stages of funding the less the present risk.
8. Comparable Method
This method literally looks at the implied valuations of other similar startups, factoring in ratios and multipliers for things that may not be similar between the two businesses.
9. The Book Value Method
This method is based solely on the net worth of the company. i.e. the tangible assets of the company. This doesn’t take into account any form of growth or revenue and is usually only applied when a startup is going out of business.
10. First Chicago Method
This method factors in the possibility of a startup really taking off, or really going badly. To do this it gives a business owner three different valuations.
Worst case scenario
Normal case scenario
Best case scenario