How do you factor in the exit strategy and the expected time horizon of the investment?

1 Market multiples

One of the most common methods to value a startup is to compare it with similar companies that have been acquired or gone public in the same industry or sector. You can use market multiples, such as revenue, earnings, or users, to calculate the implied valuation of the startup based on the average or median multiples of the comparable companies. However, this method also requires you to adjust for the growth rate, stage, and risk profile of the startup, as well as the market conditions and trends. Moreover, you need to have a clear idea of when and how you plan to exit the investment, whether through a trade sale, an IPO, or a secondary market transaction, and what kind of multiples you can expect to achieve in each scenario.

2 Discounted cash flow

Another method to value a startup is to project its future cash flows and discount them back to the present value using a discount rate that reflects the risk and uncertainty of the investment. This method allows you to capture the intrinsic value of the startup based on its expected performance and profitability. However, this method also involves a lot of assumptions and uncertainties, especially for early-stage startups that have limited or negative cash flows, high growth rates, and volatile markets. Furthermore, you need to consider the exit strategy and the expected time horizon of the investment, as they affect the terminal value and the discount rate of the cash flows. For instance, if you expect to exit in a shorter period, you may use a higher discount rate and a lower terminal value, and vice versa.

3 Venture capital method

A third method to value a startup is to use the venture capital method, which is based on the expected return on investment (ROI) of the venture capitalist. This method works by estimating the future exit value of the startup, based on its projected revenue, earnings, or market share, and applying a suitable exit multiple, such as a price-to-earnings (P/E) or a price-to-sales (P/S) ratio. Then, you divide the future exit value by the desired ROI, which is usually between 20% to 50%, depending on the stage and risk of the startup, to get the present value of the startup. However, this method also assumes that you can exit the investment at the projected value and multiple, which may not be realistic or feasible in some cases. Therefore, you need to factor in the exit strategy and the expected time horizon of the investment, as they affect the future exit value and the desired ROI of the venture capitalist.

4 Scorecard method

A fourth method to value a startup is to use the scorecard method, which is based on the average pre-money valuation of other startups in the same stage and region. This method works by adjusting the average pre-money valuation according to various factors, such as the team, the product, the market, the competition, and the risk. Each factor is assigned a weight and a score, depending on how the startup compares with the average startup. The weighted average score is then multiplied by the average pre-money valuation to get the adjusted pre-money valuation of the startup. However, this method also relies on the availability and accuracy of the data on the average pre-money valuation and the factors, which may not be easy to obtain or verify. Moreover, you need to factor in the exit strategy and the expected time horizon of the investment, as they affect the post-money valuation and the ownership stake of the venture capitalist.

5 Option pricing method

A fifth method to value a startup is to use the option pricing method, which is based on the concept of real options, or the flexibility and choice that the venture capitalist has to invest, divest, or expand the investment in the future. This method works by applying the principles and techniques of financial options, such as the Black-Scholes model or the binomial model, to value the startup as a series of options, such as the option to invest, the option to abandon, or the option to grow. However, this method also involves a lot of complexity and uncertainty, as it requires you to estimate the volatility, the exercise price, and the expiration date of each option, which may not be observable or predictable in some cases. Furthermore, you need to factor in the exit strategy and the expected time horizon of the investment, as they affect the value and the exercise of the options.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?