Startup Valuation: Understanding the Methodology — 7startup — Startup Funding Consultants
There is no one, widely acknowledged analytical process for investors because much of startup valuation depends on assumptions and estimation. To determine the worth of a business, VCs and Angels will use a variety of venture capital valuation techniques.
The application of such methods of startup valuation, depends on the stage of a company and the pertinent data points that exist in the market the firm conducts their business in. These would include data such as revenue, earnings, etc.
Identifying the Potential & Ambition
When valuing a startup, there are two areas the need to be covered:
With the use of qualitative approaches like scorecards and checklists, startups’ potential can be evaluated. These consider everything, including the founders themselves, the potency of their intellectual property, and the market they serve.
What is the rate of industrial growth? What is the rate of startup survival in the location? These provide you an idea of the startup’s theoretical capability. This is important because it requires first agreeing on the present before talking to investors about aspirations for the future.
In the second stage, the startup’s objective is evaluated using quantitative approaches to revenue forecasting, such discounted cash flow. You concentrate on the goals of the founding team rather than their capabilities, which is crucial for two reasons:
- Not everyone desires to construct a unicorn within a five-year timeframe. If money is invested on growth, certain firms have the ability to reach that level of size. However, not every founding team is interested in that scenario. Many people desire stable futures, reduced dilution, and consistent growth in a certain industry.
- Some entrepreneurs believe they can create a unicorn, yet all they possess are pieces of horses. Does the £300 million in ARR predicted by the forecasts after four years reflect the industry’s growth? Can they succeed in a cutthroat industry without an IP edge? Can they win over customers in a technological sector without seasoned founders?
You can balance the ambition and potential of a business to arrive at a value by using a strict, methodical approach to both qualitative and quantitative data. When done correctly, this type of method also has the advantage of removing the numerous biases that all too often infiltrate these choices.
Startup Valuation vs Mature Business Valuation
Well…what is startup valuation?
Startup valuation refers to the process of determining a startup company’s value (It is in the name!). Startup businesses that are now in the pre-revenue stage are frequently subjected to these tactics, making them particularly crucial. While pre-revenue investors generally favour a lower valuation that guarantees a higher return on investment, business owners will strive for a high valuation (ROI).
How do pre-revenue startup valuation and mature business valuation contrast then?
A mature publicly-listed corporation will have more concrete data to support its claims than early-stage companies. Calculating the worth of a firm is made simpler by consistent sales and financial data. The EBITDA formula, which determines a company’s worth based on its profits. EBITDA is equal to net income plus interest, taxes, depreciation, and amortisation. This is what is typically used.
It might be difficult to assign a value to a startup business that has no income because you will not have access to these numbers.
Although most startup valuation techniques do not include information on earnings, taxes, and amortisation, you would be able to take other important elements into account during the process.
Key Elements for Pre-Revenue Startup Valuation
Early-stage firms are typically valued somewhere within the centre, which means that investors end up paying more than they had originally intended to spend while entrepreneurs do not earn nearly as much money as they had hoped.
Let us examine the main elements to consider when valuing a business before it generates income.
Traction is a Conceptual Proof
Traction is one of the key metrics to consider when determining the worth of a new business without any income. Studying at the following can help you learn the real history of the company:
- Number of Users: It is critical to demonstrate that you have clients. More is always better.
- Marketing Effectiveness: Pre-revenue investors will be interested in you if you can demonstrate that you can draw in high-value clients at a relatively cheap acquisition cost.
- Rate of Growth: Demonstrating that your company has expanded on a limited budget is a terrific way to attract investors who will recognise the possibility for expansion once you have sufficient financial support.
These three ideas are connected by the fact that effective marketing will result in remarkable development. The number of users will increase when that occurs. Therefore, you instantly you build value to your startup by demonstrating that you have a workable, scalable business plan.
The Worth of a Founding Team
Investors in early-stage companies want to be confident they are supporting a winning team. They will think about the following:
- Proof of Experience: A business with a staff that comprises individuals who have had success with past start-up endeavours will be more alluring than one with many inexperienced first-timers.
- Diverse Skills: A startup team should ideally consist of a variety of professionals whose abilities complement one another. Even the most talented coder needs help from a marketing professional to grow the startup’s value.
- Dedication: Having outstanding personnel is simply one piece of the equation when it comes to commitment. To ensure that the startup is successful, those individuals must have the necessary time and commitment. A team of part-time workers will not be appealing.
Minimum Viable Product (MVP)
Showing pre-revenue investors, a functioning prototype of the product not only demonstrates your drive and foresight to turn concepts into reality, but it also brings the company closer to a launch date. You may be able to get investments in the region of £500K to £1.5M if you possess an MVP plus a few early users.
If your firm is evaluated using the valuation-by-stage technique, which is utilised by several angel investors and venture capitalists, a functional prototype might bring in much more money. Investments between £2 million and £5 million might come from this.
The startup valuation will be affected should you operate within market where the proportion of business owners to willing investors is disproportionately large. Most business owners are anxious for investment in a competitive environment that they would even offer themselves short to obtain it.
As an alternative, let us say you have a novel, patentable invention for a tech business that has been making ripples in the market. Investor demand may increase as a result, increasing the value of your business.
New Markets & Popular Trends
Investors will become more eager to pay a premium in booming businesses like artificial intelligence or mobile gaming. Your business may be valued more if it’s in the correct sector since the digital revolution is rife with chances that many consider to be the next great thing.
Later phases move the emphasis from qualitative to quantitative metrics. The two components of value might thus be considered as “assets and expectations” as opposed to “potential and aspiration.”
We at 7startup would like you to consider valuing to be similar to baking: In order to make the best piece of bread available, you must ensure that your components are of the highest calibre and that your method and timing are exact. Quantitative in one and qualitative in the other. Both are scientific when approached properly. They are crucially repeatable, trustworthy, and reasonable.
Originally published at https://www.7startup.vc on August 9, 2022.