4 ways to value a startup: what you need to know

entrepreneurStartupstips

When valuing your startup in order to start a financing round, it’s important to enter any conversation with a wealth of knowledge to help you along the way. The key is to be able to justify what you think your company is worth in a way that is acceptable by you and the market.

We are certain of one thing: with the knowledge provided on our blog, you’ll be able to get a full spectrum of perspectives and specific information to be able to ensure a fair valuation.

It’s never an easy task to value a company. There are many factors to take into account and it often seems to involve a lot of guesswork, even more so when looking at new ventures. By educating ourselves about each approach and the world of startups in general, we’ll be much better equipped to defend our valuation in front of investors.

1- Market multiple approach

This approach is often favoured by venture capital investors. What does the approach entail exactly? It aims to evaluate a company against recent funding rounds or acquisitions of similar companies on the market. The approach allows you to know what real investors have been willing to pay for a company recently. This proves to be effective in forecasting success of certain deals or investments in comparison to others.

When considering the market multiple approach, it’s important to remember that it’s not always easy to find comparable companies, particularly with highly-innovative ideas and this can prove to be a catch when considering this strategy.

Sales

Let’s say that home technology companies are seen to be selling for five-times sales. Knowing this information, you could therefore evaluate your technology device company at the same basis, that’s to say five-times sales, while moving upwards or downwards depending on different defining characteristics. In SaaS environments, the most common basis used would be ten-fold rather than the five-fold example given above.

Startups can certainly be evaluated based on revenue multiples in addition to detailed and in-depth forecasting of potential success of a product or service, analysing market performance, case studies and the startup’s USP and how this might influence revenue.

Gross merchandise value (GMV)

In marketplaces and ecommerce, GMV is often used as a clear favourite in terms of company valuation. It sets out a seemingly clear formula for evaluating and obtaining workable results information. So, what does it consist of? GMV involves the following equation:

(Price per item or service charged to the customer)∙(number of items sold)=GMV

To put this in basic terms, if you sell beach shorts for 10 euros and you sell 10 pairs, your GMV would be 100 euros in total, regardless of the commission of your marketplace that your company gets as revenue.

GMV figures neglect other essential information, such as which customers are making repeat purchases and visits to a marketplace or website, for example. GMV focuses much more on hard sales figures in terms of earning and we all know that there is an array of pertinent factors to be weighed up when evaluating the health of a startup

2- Cost to duplicate

This approach tends to come into play from a physical assets angle. As we can see in the name given to this approach, it refers to the amount of money that would be needed to build another company just like it from the ground up. There are many downsides to this approach and we’re sure they’ve already come to your mind. A company’s net worth might only be minimally represented by its infrastructure and equipment and that’s before considering that this approach lacks any ability to consider future potential for profit or sales generation.

3- Discounted cash flow 

DCF revolves around the forecasting of future cash flow a company might produce and then calculating how much that cash flow is worth using an expected rate of investment return. In the particular case of startups, a higher discount rate is usually applied considering a much higher risk of failure to meet sustainable cash flow levels.


Bear in mind that this approach depends almost entirely on the ability and skill involved in predicting future cash flow success and this can be harder during uncertain times or after lengthier periods. We certainly do not recommend this approach for startups.

4- Corporate synergy

This happens when another player in the sector decides to buy you out but with a very clear strategic benefit. This is a buzzword in Mergers and Acquisitions, and proves to be positive when the unison is fruitful. Synergies are often calculated in the following way:

Synergy=NPV Net Present Value+P (premium)

Factors include revenue increase, expenses reduction, optimisation of processes and financial economy factors.

Sometimes these transactions prove to be more strategically thought out, even if that implies a loss initially. However, long-term benefits and the potential of the brand’s name or customer base tend to be favoured. 

Widely-known examples that can provide us with case studies include Paypal acquiring Honey, Walmart acquiring Jet.com or Google opting for Nest. 

What’s next? Be guided by our expertise

If one thing’s certain, it’s the need to assess each startup individually, taking into account specific market factors, the current climate and context. At The Startup CFO, that’s where we come in. Our in-depth array of expertise in terms of funding rounds and sales will ensure you use this knowledge guided by our professionals.

More info at info@tscfo.com

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