Looking for the ultimate guide to valuing startups? Any type of business valuation is never straightforward. Assigning a valuation to a startup with little or no income and an unclear future is especially difficult.
Experts use more straightforward formulas, facts, and figures for the valuation of mature organizations. That is, companies trading publicly and having consistent revenue.
On the other hand, a startup is significantly more challenging to value because they are tackling new things. They may not have a long track record, and may not even have any income.
If you need to raise money for your startup, you’ll need to figure out how much it’s worth. So, what is the best way to value your startup?
The Ultimate Guide To Pitch Decks
When and Why Valuations are Needed for Your Startup
A business valuation can be beneficial at any point in your startup’s development, but you’re more likely to need one in the following situations:
- When it comes to securing investment: Most investors will want to know how much your startup is worth (or how much it could be worth in the future). That’s how they can figure out how much equity they’ll get in return for their money, as well as the growth potential.
- Boosting productivity and growth: A business valuation is frequently included as part of a company review. Having a clear image of how things are progressing in your startup can assist motivate and encourage your employees to achieve greater success.
- When creating an internal share market: Knowing your company’s value will help you determine a fair and competitive price for employee stock purchases and sales. You can also utilize it to keep current and potential shareholders informed about the startup’s performance.
- It’s time to sell your startup: If you ever want to sell your startup, you’ll need to know how much to ask.
Keep in mind that in fundraising, storytelling is everything. In this regard for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
Factors Affecting the Value of Your Startup
You need to consider several factors when valuing your startup, and it’s not just about monetary values.
A startup is only worth what someone is ready to pay for it, which might be a very subjective assessment. Instead of only referring to your financial reports, think about the following when calculating a value:
- The reasons for the valuation: Your value is proportional to the magnitude of your negotiating position. If you’re valuing your company because you’re forced to sell it, the final value will be lower. Your startup’s value is higher if you value it to attract investment and accelerate a growth period.
- Your product’s strength: For a strong valuation, you’ll need a strong product, a robust delivery plan, and an expanding audience that’s interested.
- The people who make your company what it is: Your team plays a critical role in determining your value. A devoted, energetic, and skilled workforce committed to moving your company forward will make a significant difference in your overall value.
- Your company’s age and/or potential: On the surface, an older company with a solid reputation and recurring revenues may appear to be more valuable than a startup. However, don’t underestimate the importance of potential. A young, enthused startup with a vast potential market and a long future ahead of it may be more attractive to investors. More than an established company with a less future-proof product.
Read ahead for more information that we’ve included in the ultimate guide to valuing startups.
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How Startups Get Valued
The value of a startup can get determined through one of the following methods:
- Berkus Approach
- Cost-to-Duplicate Approach
- Future Valuation Method
- Market Multiple Approach
- Risk Factor Summation Method
- Discounted Cash Flow (DCF) Method
Let’s go through each method individually to understand them better.
Angel investor and venture capitalist Dave Berkus developed the Berkus Approach. It focuses on evaluating a startup through a thorough examination of five critical success factors, namely:
- Basic value
- Strategic relationships in its primary market
- Production and subsequent sales
To assess how much value the five primary success criteria provide to the enterprise’s entire worth in quantitative terms, you’ll conduct a thorough analysis. These numbers determine the startup’s value.
The Berkus Approach can also get referred to as:
- The Stage Development Method
- The Development Stage Valuation Approach
The Cost-to-Duplicate Approach entails factoring in all fees and expenses related to the startup and product development, including purchasing physical assets.
You’ll consider these costs in determining the startup’s fair market value based on all of the expenses.
Disadvantages for the cost-to-duplicate method includes:
- The company’s future potential is not a factor when making projection statements of future sales and growth.
- Not taking into account its intangible assets in addition to its tangible assets. Even at the beginning stage, the idea here is that the startup’s intangibles, such as brand value, intellectual rights (if any), goodwill, etc., may have a lot to offer for valuation.
Future Valuation Multiple Approach
The Future Valuation Multiple Approach focuses entirely on calculating the return on investment (ROI) that investors might expect in the immediate future, like in the next five to ten years.
Several estimates are made, including:
- Five-year sales projections
- Growth projections
- Cost and expenditure projections
The startup is valued based on these estimates for the future.
Market Multiple Approach
One of the most commonly used approaches for valuing startups is the Market Multiple Approach. The market multiple approach works in the same way as other multiples do. And is a critical element of the ultimate guide to valuing startups.
Investors consider recent market acquisitions of a similar nature to the company in question. Next, they calculate a base multiple using the value of the recent acquisitions.
The startup then gets an appraisal using the market multiple as a starting point.
Risk Factor Approach
The Risk Factor Summation Approach evaluates a startup by quantifying all risks related to the company that could affect the return on investment.
Investors factor the influence of various business risks, whether positive or negative into this starting value. Then they remove or add an estimate to the beginning, value based on the risk’s effect.
You’ll establish the ultimate value of the startup after taking into account all types of risk and applying the “risk factor summation” to the startup’s initial estimated value.
Types of startup risks include:
- Legal environment risk
- Management risk
- Market competitiveness risk
- Political risk
- Investment and capital accumulation risk
- Technology risk
- Manufacturing risk
Discounted Cash Flow Approach
The Discounted Cash Flow (DCF) method helps forecast a startup’s future cash flow movements. The “discount rate,” or rate of return on investment, is then calculated and applied to the expected cash flow’s value.
Because startups are still in their development and investing in them entails a high level of risk, a considerable discount rate is frequently used.
For this reason, this approach is a must-add to the ultimate guide to valuing startups.
How to value a startup with no revenue? If you need more information about how that’s done, check out this video I have created. You’re sure to find it helpful.
How to Increase the Value of Your Startup
Entrepreneurs have a lot of work cut out for them when it comes to selling their startups.
Aside from the complexities of the process and emotions involved, entrepreneurs must ensure that the startup’s value they’ve invested so much time and work in is maximized.
Another reason why you need to increase a startup’s value is if you intend to raise more funds in the future.
Here’s what you can do to increase the value of your startup when you’re interested in selling:
This is especially important if you intend to sell your startup and prepare your company for sale. You should get the advice of an experienced outside advisor.
This professional can assist you in preparing your company for sale, including obtaining an expert valuation. One of the crucial stages in your career as an entrepreneur is selling your company.
Professional assistance will ensure that you get it correctly the first time.
Increase your profits
If you’re barely breaking even, don’t expect big offers. You also want to avoid draining too much money from the startup.
Buyers and investors can tell if a startup is lucrative and healthy by looking at its retained earnings. This is the part of net income that hasn’t been given to shareholders.
Lower expenses and increase sales
Analyze your procedures and determine ways to improve operational efficiency, reduce costs, and keep inventories under control without disrupting your business.
Refresh your marketing strategy and look for new ways to increase sales, such as tapping new markets or introducing new products and services.
Concentrate on building a diverse customer base that provides revenue streams.
Continue to improve and invest
Once you’ve decided to sell your startup, you can’t stop with the day-to-day operations of your business.
When you forgo investing in new equipment, process upgrades, and maintenance, you begin to reduce your startup’s future value.
Develop a strategy plan
A detailed strategy plan with quantifiable goals and milestones for the next few years can establish your startup as a developing company with long-term possibilities.
Create repeatable processes and give your team the tools they need to succeed
Your company’s procedures must be repeatable and teachable. You’ll have difficulty selling your business if it can’t operate without you, so your employees should be trained, motivated, and empowered.
You should also pay attention to the management staff in particular. Work to resolve any internal disputes and maintain a low employee turnover rate.
A well-trained, competent workforce adds value to a company, especially when there are few tangible assets.
Make an impression
Selling your company is a marketing challenge in itself. That’s why it’s essential to show potential customers what sets your product or service apart from the competitors.
Request testimonials from some of your long-term customers, detailing why they do business with you and what keeps them returning.
Check out the ultimate guide to valuing your startup when you intend to raise more funds in the future.
Have a previous successful exit
This will improve your chances of raising it at a higher valuation and obtaining finance.
Carefully select your team
You should consistently recruit cautiously, but you should choose your recruits much more meticulously if you intend to obtain equity funding.
Choose people who are not only leaders in their profession but also experts.
Choose important milestones
If you meet your milestones, milestone financing enhances your startup’s value with each fundraising round.
They could focus on consumer traction, team objectives, or technical development and should be unique to your company.
Think about how you’re going to define your milestones
You’ll lose credibility if you pick ones that you won’t be able to achieve. After you’ve defined them, create a budget based on the costs you estimate to incur to fulfill them.
This will determine the magnitude of your request. To accommodate for unanticipated setbacks, always add a 25% cushion.
Decrease your burn rate
Investors will always look at your burn rate versus your growth rate, even if traction means various things to different people.
Negotiate your fundraising terms
The more people interested in your business, the greater your valuation will be. Allow Venture Capitalists to come up with numbers initially as part of your negotiating technique, then play investors off one another.
Don’t make any decisions without having the facts and know how much you can get for your business.
Timing is everything
Is it a hot market in your area? Is your industry attracting a lot of interest from investors? If that’s the case, now is the time to start looking for money to invest.
Investors determine much of your startup’s value by how they see your market and sector right now. Hot markets come in cycles, and current investor opinion accounts for a significant portion of startup valuation.
We have created the ultimate guide to valuing startups keeping the needs of entrepreneurs in mind. Use this information to attract valuable funding for your business.
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