Startup Valuation: Estimating the value and performance of a startup, is an important part of the fundraising process because it helps founders determine how much money should be offered to investors.
It is also a measure by which investors estimate future profits. So it’s not possible to come up with a random number and claim that’s your company’s valuation. It takes math and all the data to come up with a fair and acceptable valuation.
But valuation is NOT an exact figure, as a company’s true value cannot be known, and a lot of startups are yet to generate revenue and profits. Therefore, valuations are mostly conjectures agreed upon between the founder and the investor. The only thing it shows is how much the market is willing to pay for a startup and how willing the founders are to accept that number.
And since valuation is often determined when transactions like investments or acquisitions take place, much of the value also depends on how the founder and investor negotiate. And founders should be wary when a transaction appears to be undervalued or overvalued.
Being overvalued will make the next round of fundraising more difficult. So in case no one tells you this, just remember: If your startup is unbelievably overvalued, you might want to consider asking for less. “Meaning negotiate down?” “Yeah” “Can do that?” “YES”.
Still undervalued will be diluted in the previous rounds, but overall, this is a minor issue if the company is doing well. At the next stage, you can raise at a better valuation with less dilution later on.
Valuation is one of many indicators of success, not the only one. Getting caught up in business valuation will distract the founder from running a good business. Entrepreneurs need to focus on creating value. Focusing on business development will not lack investors. Above all, investment deals should not be seen as merely an opportunity to earn additional capital. Investor can also act as a mentor and advisor to the founder. There are many cases when founders and investors get stuck discussing valuation and forget that a potential partnership between them would be more profitable for the parties involved.
Finally, it’s important to remember that we’re in the long haul and there will be times when you’ll make mistakes and the company is going through a tough time. At that point, you’ll want to build a sufficient trust base with shareholders that they’ll be willing to bang the table for you before their IC committee or their fund because of their faith in you.
So no matter if it’s a VC or a startup founder, take a really long-term view of negotiating terms and pricing rather than pushing every penny, for money or those fringe terms, Honestly, it won’t work in the long run. But the relationship you build with your shareholders will be more helpful and impactful.
SOME METHOD OF STARTUP VALUATION:
1. Discounted Cash Flow (DCF): This method calculates a startup’s valuation based on the present value of expected future cash flows.
This method often focuses on the company’s numbers, without taking into account market factors such as investor enthusiasm, meaning that using this method can ignore market considerations. important. This model requires accurate figures for revenue and expense projections (recommended for startups in series D or higher, early stage startups will have a hard time predicting exact numbers).
2. Relative method: compare key business/financial metrics of the business with other companies in the industry. This method provides comparison and checkpoint for founders and investors, as it uses other companies in the industry as a benchmark.
However, it is susceptible to market hype, meaning the number could be overvalued or undervalued, depending on investor sentiment towards the industry in question.
3. Valuation Multiples Method: this method is the most favorite because it can be applied to almost any startup, any stage or industry. The first thing to do is determine the multiples.
Some common ways (The numerator is the inherent value of the company, and the denominator is the main business/financial metric):
- Enterprise value/Revenue
- Enterprise Value/EBITA
Once the multiples have been determined, the next step is to find the points of comparison. To do this, make a list of comparable companies (“comps”). Must be companies in the same industry, ideally at the same size and maturity level as your business. Compare with public companies, because they will make the data public. If you want to compare with other startups, check the latest funding rounds to get the right number.
If you’re valuing a startup’s next 12 months of revenue, you’ll also need to compare it to revenue next 12 months. Based on that, you can calculate the multiples of each comps. That leads to the final step – applying multiples. Based on the company multiples, you can apply the average to the numbers to calculate the value. However, because valuation is not an exact science, remember to stress test the numbers. You can also look at the 25th and 75th percentiles as guidelines to give you a range for your valuation.
In case you are a bit confused, let’s come to the example of Fancy Fintech Ltd. The startup is about to call a series A round, with $10 million in sales last year and growth forecasts this year.
Founder of Fancy Fintech decided to use Enterprise Value/Revenue as the main multiple because it is simple and easy to compare. Then find competing fintech businesses and come up with a list of 3 to 6 that are relative in terms of size, product, business model, and geography. Then calculate each ratio Enterprise ValueRevenue of the company. Finally, apply multiples.
For Fancy Fintech, their average Enterprise Value/Revenue ratio is 8x. So take the revenue of US$10 million multiplied by 8 to get a pretty viable amount of US$80 million.
In general, which valuation method you use largely depends on the original rationale. In addition to the method above, you can choose from other less common valuation calculations, each with different use-case applications such as:
If you are an investor and are looking to acquire a company, you can also consider duplicating pricing. Let’s say, as a company when buying a startup, how much does it cost me to recreate this startup.
A prime example was when Google acquired YouTube in 2006. At the time, Google had a competing video product, Google Video, but in its review, the tech giant determined that it was in order to start. keeping up YouTube will cost more than acquiring it.
In addition, how the value is determined will also depend on the stage of development of the company, mainly because investors look at different aspects of a business, depending on its maturity:
During the seed round, investors will consider whether the idea is a promising idea and business potential. So it depends a lot on the aspirations of the founders, as there are not many achievements or traction to judge.
- In series A, there are many factors that go into whether you have said what your aspirations are? And how is the business? Will you be able to follow through on what was said?
- In series B, they will determine if you are a market leader or not? Because if this industry and business is something right, there will be more than one player, and the question is are you a top player? Because the market leader has a higher chance of survival and a higher probability of success.
- In series C, the focus is on profitability as a company.
After all, the above formulas are still just formulas. Since valuations are often determined when investments or acquisitions take place, the founders’ ability to negotiate throughout these processes is also important. It is for this reason that many people consider startup valuation to be both an art and a science.