How startups are valued during an acquisition? While billion-dollar startup stories seem to be everywhere, the average exit is still really only around $150 million. Where on this scale will your startup acquisition land?
It’s important to know what your company is worth. You don’t want to throw out a ridiculously low offer and sell yourself short by a billion.
Nor is it smart to hold out for an insane number that will get you ignored by serious buyers. As a founding executive, you also have a responsibility to your investors and need to be able to justify the numbers to them.
It can be a bit of an art to figure out how startups are valued during an acquisition. Especially an early-stage startup. Some will just say “it’s worth what someone will pay you for it.” That may be true, but there is a little more to it than that.
Factors Impacting How Much Your Startup is Worth
Some of the many factors influencing the value of your startup and the offers you can command include:
- The current market
- Who is buying you
- Competition to buy you
- How they are paying (cash or stock)
- The clauses in the term sheet (i.e. earnouts)
- Recent valuations at fundraising rounds
- The moat you have around your business (or not)
- How organized you and your documents are
- The strength of your relationships with potential acquirers
A great pitch book and story can go a long way before you even get to the point of thinking about how startups are valued during an acquisition. Mastering the storytelling side and how you are positioning your business is done via your acquisition memorandum. For a winning acquisition, memorandum template take a look at the one I recently covered (see it here) or unlock the acquisition memorandum template directly below.
Common Approaches and picking the best valuation method
Here are some of the most common methods showing how startups are valued during an acquisition.
1) Earnings Multiples
Mature businesses and public stocks are measured in multiples of their earnings. In quarter one 2019 CSI Market reports the average price to earnings ratio in technology averaging almost 30%.
Software and programming businesses were trading at an incredible ratio of 43.53. Note that is far above historical averages for the stock market as a whole.
The main problem with this methodology for many startups is that they have no net profit, and maybe no meaningful revenues at all.
2) Your Number
If you have investors and co-owners you have a legal responsibility or fiduciary duty to them. You can’t just ignore reasonable offers. However, you should have a number in mind.
If you’ve been bootstrapping, you might have the only call on whether to take an offer or not. So, how much do you need to walk away with to make it worth it for you?
Most entrepreneurs seem to settle on not necessarily becoming obscenely wealthy, but a figure that will significantly change their lives and financial position for their families. Ideally enough to stick a few million in a retirement account, something substantial to fund your next project, and enough to make some meaningful donations.
3) The Comparable Approach
This is probably the easiest valuation method to understand in order to calculate an estimate on the back of a napkin. What are other similar startups in your space, of similar size selling for?
Note that startup valuations for fundraising purposes can be different. What are acquisition prices? Or IPO prices?
You may be able to break this down by users and make adjustments for the size of your business. For example; you have a ride-sharing business, Uber just went public for $X with so many users. You have Y number of users.
4) Cost to Duplicate
How much would it cost your acquirer to just replicate what you’ve built? This is a good valuation method to find how startups are valued during an acquisition given the potential financial model that could be put in place in order to come up with some estimations.
They have the financial resources. What would it take them in investment to hire a team that mirrors yours, build the prototype and get to the same stage? You’ll probably need to be a little under this number for it to make sense for them to buy versus build.
5) Discounted Cash Flow Method
This valuation method may be particularly useful in pre-revenue startups. It makes a prediction of potential cash flow (ideal for a strategic acquirer), factors in a desired rate of return, and applies a discount to account for risk.
The earlier stage the startup, the higher the risk, and the deeper the discount.
6) Other Valuation Methods
When figuring out how startups are valued during an acquisition additional valuation methods include the Venture Capital Method, Berkus Method, and the Book Value which looks at the tangible value of assets and maybe most useful in an asset sale or liquidation.
There is also the Scorecard Valuation Method which scores a startup on various factors such as opportunity size, team strength, need for more capital and sales channels. Each investor and buyer may put different weight on each of these factors.
There are actually many valuation methods to price startups. The valuation method may be different from each potential acquirer too, and depend on why they are buying.
Do they really plan to integrate it and have a plan to maximize profit and sales? Are they buying you just to shut you down? Or are they buying to get a return and cash flow?
Above all, know that you are still the master of your own destiny. The math may be the math, but what you do with your pitch book can make a dramatic difference in the price you demand and how happy you are with your exit.