Are you a startup founder, an entrepreneur, or an investor, learn about valuation of startups and everything you need to know.
Entrepreneurs frequently assign value to their startups when they seek funding or when they distribute shares to their staff, advisory board, and advisors. It’s crucial to accurately assess your business startup because if you overvalue it, investors can decide not to offer you any money.
Conversely, undervaluing your startup implies either undervaluing what you have already accomplished or giving up a significant amount of stock for less money.
What is Valuation?
Valuation is the process of estimating the worth of an asset or company but putting into account so many attributes like the development stages, sales, current business ties, market proof and other things.
Valuation of startups play huge roles as it provides prospective buyers with an idea of how much they should pay for an asset or company and for the company owners or asset owners, how much they should sell.
Read – Business Planning for Startups.
Things to Take into Account Before Startups Valuation
- The development stage of the product or service.
- Market proof of concept.
- The CEO and their team.
- Valuations of rival companies or startups with a comparable business model.
- Current business ties with clients and important partners, and
- Sales are all taken into account when determining the valuation.
Read – Crowdfunding for Startups
How can I figure out how much my startup is worth?
You can use a variety of strategies and procedures like:
- Your startup stage and accomplishments will determine this.
- We advise doing idea validation and market valuation if your startup is still in the idea stage.
You can begin working on analyzing your idea based on the early customers’ rate and the revenues once you have begun working on concretizing and verifying your idea.
Given that the firm is still in its early stages, the valuation should take it into account (for example, a startup in its early stages that generates $10,000 per month might be regarded as “high-value”).
Additionally, it’s critical to consider the cost of sales, the expense of gaining new clients, and the net income produced (margins of sales).
If your startup is already making money, you may estimate its value using its cash flow and revenue.
Read – 11 Grants for Startups
Calculating Startup Valuation
Many online calculators, such as those offered by;
- EquityNet
- Caycon
- EnterpriseMonkey, can assist founders in roughly evaluating their startups.
- FasterCapital has a staff that is dedicated to valuing your startup.
The main issue with many online calculators is that because their profitability depends on how frequently business owners recommend this way of calculation to others, they frequently overvalue startups to please business owners.
It’s also important to note that many of these online calculators use Silicon Valley or American startups as their examples! You may find it strange, but the startup’s nation of origin has a significant impact on the valuation.
Some online calculators offer a range, which we believe will be more useful. However, it might be a good starting point to check your startup valuation using one of these online calculators before moving forward into more accurate and holistic methods.
In general, such online calculators are useful to have a rough estimation but not accurate enough because they consider all factors. FasterCapital has a staff that is dedicated to valuing your startup and providing you with an honest and fair assessment. The valuation will typically be a range offered by a study.
Read – Tech Startups in Nigeria.
How Startup Ventures Are Valued
For any organization, business valuation is never simple. To value your startup, check methods like:
- Cost-to-duplicate
- Market multiple
- Future Valuation multiple approach
- Discounted Cash Flow (DCF)
- Valuation by Stage
Assigning a valuation to startups with little to no revenue or earnings and uncertain futures is a difficult task. It usually involves valuing established, publicly traded companies with consistent revenues and profits as a multiple of their earnings before interest, taxes, depreciation, and amortization (EBITDA) or based on other industry-specific multiples.
However, it is much more difficult to assess a startup that is not yet publicly traded and may be years away from making any money.
1. Cost-to-Duplicate
As the name suggests, this strategy entails estimating the price tag required to start a competing business from scratch. According to the theory, a wise investor wouldn’t spend more than it would take to duplicate anything. This method frequently examines tangible assets to ascertain their fair market worth.
For example, the entire cost of programming time spent on building the software used by a software company could be used to estimate the cost to reproduce that firm. It can be the expenses incurred to date for R&D, patent protection, and prototype development for a high-tech startup.
Since it is fairly objective, the cost-to-duplicate approach is frequently used as a starting point for valuing businesses. After all, it is founded on historically verified expense records.
The main issue with this strategy—and business founders will undoubtedly concur here—is that it doesn’t take into account the company’s potential for future sales, profitability, and return on investment.
Additionally, the cost-to-duplicate strategy leaves out intangible assets like the brand value that the venture might have even in its infancy. It’s frequently employed as a “lowball” assessment of firm value because it typically underestimates the venture’s value.
When relationships and intellectual capital serve as the foundation of the organization, the physical infrastructure and equipment may make up a relatively small portion of the actual net worth.
Read – Top 35 Startups in Nigeria.
2. Market Multiple
This strategy is popular with venture capitalists since it offers them a good idea of what the market is ready to pay for a firm. In essence, the market’s multiple approaches compare the company’s value to recent purchases of businesses in the same industry.
Assume that companies who develop mobile application software are selling for five times sales. You might use a five-times multiple as the starting point for pricing your mobile apps business while changing the multiple up or down to account for different qualities if you know what real investors are prepared to pay for mobile software.
Given that investors are taking on greater risk, your mobile software startup, for example, would likely fetch a lower multiple than five if it were at an earlier stage of development than other comparable businesses.
Extensive predictions must be made to estimate what the sales or earnings of the business will be once it is in the mature stages of operation to value a firm in its infancy. Even before a company is making money, capital providers frequently give it money if they believe in the product and business model of the company.
While the value of many established firms is based on profitability, startups frequently have to be valued using revenue multiples.
The value estimates provided by the market multiple techniques may be the ones that are closest to the prices that investors are ready to pay.
The problem is that it can be difficult to locate comparable market transactions. Finding comparable businesses can be challenging, particularly in the startup sector. Early-stage, unlisted companies, which are likely to be the most comparable, frequently keep deal terms a secret.
3. Future Valuation Multiple Approach
The Future Valuation Multiple Approach is primarily concerned with determining the expected return on investment for investors in the next five to 10 years.
The company is valued based on a number of estimates that are made for the aforementioned reason, including sales projections over a five-year period, growth projections, cost and expenditure projections, etc.
4. Discounted Cash Flow (DCF)
The main source of value for the majority of companies is their potential for growth in the future, particularly those that have not yet begun to generate profits. Therefore, discounted cash flow analysis is a crucial method of valuation.
Using an anticipated rate of return on investment, DCF entails estimating how much cash flow the company will generate in the future and determining how much that cash flow is worth. Startups often face a higher discount rate due to the high likelihood that they won’t be able to produce stable cash flows in the future.
The problem with DCF is that its quality depends on how well the analyst can predict future market conditions and create accurate long-term growth rate assumptions. Projecting sales and profitability for more than a few years can frequently turn into a guessing game.
Moreover, the estimated rate of return employed for discounting cash flows has a significant impact on the value that DCF models provide. DCF must therefore be used very carefully.
5. Valuation by Stage
To swiftly estimate a general range of company value, venture capital firms and angel investors frequently employ the development stage valuation approach.
According to the venture’s stage of commercial growth, investors often set these “rule of thumb” figures. The company’s risk is lower and its value is higher the further along the development road it has advanced.
Valuation By Stage Model
A valuation-by-stage model might resemble the following:
| Estimated Company Value | Stage of Development |
| $250,000 – $500,000 | Has a compelling business idea or business plan |
| $500,000 – $1 million | Has a substantial management team in place to implement the plan |
| $1 million – $2 million | Has a final product or technology prototype |
| $2 million – $5 million | Has strategic operations or partners, or signs of a consumer base |
| $5 million | Has precise signs of income growth and an evident pathway to profitability. |
Once more, the specific value ranges depend on the company and, of course, the investor. However, investors will likely give the lowest valuations to firms with little more than a business strategy. Investors will be willing to place a higher value as the company meets development milestones.
A common strategy used by private equity firms is to increase capital after the company hits a specific milestone.
For instance, the initial round of funding could be used to pay personnel to work on product development. A further round of funding is given to mass-produce and promote the idea after it is a success.
Startup Valuation for different Phases
The startup valuation for different phases are:
- Seed round valuation
- Series A Valuation
- Series B Valuation
1. Seed round valuation
At this point, startups typically have limited income and traction. Before you have established a product-market fit, it can be difficult to value a seed-stage firm. An excellent strategy to value your startup is to establish distinct goals that you will reach in specified timeframes and figure out what sources you will require.
Additionally, knowing the market’s demand and level of competition for the product will help you determine the worth of your seed firm and what to bargain for when dealing with VCs and angel investors.
Applying a comparable strategy is the best way to determine the worth of a seed-stage startup with no track record of success. The startup is compared to other seed-stage companies in the same sector, and region, with a comparable business plan, and with a comparable market size.
Quick Tip for Seed Round Valuation
At this point, don’t overvalue your startup. Most business owners estimate their financial needs for the next 18 months and multiply that amount by 5 or 6 to get a valuation. It’s based on the rule of thumb that you should not give away more than 15% to %20 at each round of funding!
Typically, this is incorrect. Your startup will be grossly overvalued, and the funding will not be approved. It is best to estimate how much money you will need over the next six months and to be extremely cautious while raising funds.
Try a lesser budget like $100k instead of, for example, $300k for marketing, and utilise it to gauge how the market would respond to your offering. By doing this, you will be able to raise less money while still maintaining a reasonable level of self-sufficiency.
Always perform a thorough financial study and develop a value proposition for your firm to prevent acquiring an overvalued business. This will assist you in setting reasonable expectations for investors and keep you on course while your business is growing.
2. Series A valuation
Entrepreneurs may receive various term sheets from investors during series A rounds, making it challenging to determine the startup’s proper valuation. You have the option of valuing your firm based on revenue, user count, product demand, potential market, and other elements that demonstrate traction and key performance indicators.
Many business owners base the Series A valuation of their company on expected future revenue. They are right in doing so because the startup has already produced some revenue and its business model is tried and true.
The issue is that if you don’t accomplish those objectives, VCs and angel investors may have second thoughts about your performance and may feel overpaid. We advise you to include a condition in the contract that allows you to modify the amount to be raised or the equity granted based on the company’s performance over the next six, twelve, eighteen, or twenty-four months to resolve this issue.
For instance, if a business is raising $3M on an $18M valuation, the value or the amount to be funded could be adjusted based on future performance and financial performance. Analyzing your financial operational model can help with this.
3. Series B valuation
Series B startups would have already established themselves and had a track record, simplifying the valuation process.
Because entrepreneurs can now demonstrate strong growth potential and a track record with angel investors and venture capitalists, the valuation of series B firms is typically higher than that of series A startups.
Due to their development stage, series B businesses typically receive greater investment from VCs. The performance of the startup, its assets, and revenue projections, together with other acceptable series B stage valuation approaches, can all be used to determine the valuation of series B startups. Series B valuation can also be done using the post-money valuation approach.
Quick Note on Series B Valuation
The following criteria are typically used to evaluate startups:
- Business model
- Business techniques
- Unique selling proposition (USP)
- Financial analysis
- Market potential
- Competitive landscape
It’s critical to have a firm grasp of a startup’s business model before evaluating it. This model should outline the startup’s main revenue stream and market share expansion strategy. The startup should outline its goals and the steps it will take to attain them in its business strategy.
For investors and customers to understand why they should choose the startup over competing goods or services, the USP, or unique selling proposition, should be carefully considered. It is what distinguishes the startup from its rivals.
While market potential can be evaluated by taking a look at elements like population size, economic conditions, customer wants, and trends, the financial analysis should give an overview of the startup’s current financial situation and prospects.
The final step in analyzing the competitive environment is to determine which companies presently control that specific market niche and how the business intends to compete with them.
Conclusion
A company’s exact value is very difficult to ascertain in its early stages because it is still unclear whether it will succeed or fail. However we listed methods that will aid you in the journey of determining your startup valuation.
The valuation of startups is said to be more of an art than a science. That holds a lot of truth. The methods we have seen, however, contribute to a slight increase in the art’s scientific rigor.
