How do you choose the best valuation method for your startup?

Choosing the best valuation method for a startup requires considering factors such as the stage, industry, revenue/profitability, exit strategy, availability of data, and investor preferences. Early-stage startups may use methods like DCF, while later-stage may use comparables. Technology startups may be valued differently than real estate. The exit strategy can impact the method used, and data availability matters. It's crucial to understand what investors are looking for and what method they prefer.

For a startup, this is the one I usually default to. Look at other startups in your sector, benchmark your metrics to theirs, and find some way to take a multiple from this process. Maybe it's a multiple on ARR. Maybe it's based on number of users. Either way, you'll have some way to justify a price for your company.

Many first-time entrepreneurs think that their start up is of value only when they have a book of business. It is important to note that your startup might be of significant value if you have a MVP of the solution that addresses a real problem even though you have no or some customers in the PILOT phase. Don't discount the vision, strategy and IP while thinking about the valuation of your startup.

The Income Approach of Valuation for startups focuses on future cash flows, offering insights into long-term value, ideal for businesses with stable revenue streams. It incorporates risk assessment by discounting cash flows to present value using a risk-adjusted rate, enhancing accuracy. However, reliance on projections introduces uncertainty, as assumptions can be biased or inaccurate. Moreover, it's complex and time-consuming, demanding detailed financial analysis for cash flow estimation and discount rate determination. Pros: - Focuses on future cash flows - Incorporates risk assessment Cons: - Relies on projections - Complex and time-consuming

Introduced by Bill Payne in the early 2000s, the Payne Scorecard Method evaluates startups by grading various business aspects, akin to the Berkus model. Each element carries different weights, and the aggregated factors are multiplied by the average valuation of comparable companies. Pros include a more comprehensive evaluation compared to Berkus. However, like Berkus, it remains subjective and lacks precision. Nonetheless, it outshines Berkus with its detailed approach, making it a favorable choice for early-stage investors seeking quick and relatively detailed valuations.

The Venture Capital Method, pioneered by Harvard Business School's Professor Bill Sahlman in 1987, offers a unique perspective on startup valuation. It begins with a post-money valuation based on anticipated future exits. This method assumes post-money valuation equals pre-money valuation plus investment. By iteratively subtracting layers of valuation, it estimates the current pre-money valuation. Pros include quick calculation aligned with investor returns, while cons include its high-level nature and limited accuracy. It provides a rapid estimation, catering to venture capitalists' expectations.

The discounted cash flow method is the most used method to value a business – and it is the valuation method that makes the most sense for start-ups. Entrepreneurs who’ve had to seek outside funding have likely had to create pro forma financial statements for 5 years or more for their business. These pro forma financial statements can be the basis for a discounted cash flow business valuation. Why is doing the business valuation for a start-up important anyway? Because how else can the entrepreneur know how much ownership to give away related to any proposed angel or venture capital equity investment?

Valuations also are broadly separated into two buckets: 409A valuations used to price employee stock options, and post-money valuations set by investments. Two good basic articles to learn more: https://carta.com/blog/what-is-a-409a-valuation/, https://carta.com/blog/409a-valuations-for-founders/