Startup Valuation Methods?

Valuing a startup is one of the most challenging tasks often required by financial analysts. In this article, we will discuss how to value a startup as well as some of the more popular valuation methods. Startups, in the most general sense, are new business ventures created by an entrepreneur. The startups usually tend to focus on developing unique ideas or technologies and introducing them into the market in the form of a new product or service.

Key Highlights

• Startups, in the most general sense, are new business ventures started by an entrepreneur.
• The various methods through which the value of a startup is determined include the Berkus approach, cost-to-duplicate approach, future valuation method, the market multiple approach, the risk factor summation approach, and discounted cash flow (DCF) method.

Berkus Approach

The Berkus approach, created by American venture capitalist and angel investor Dave Berkus, looks at valuing a startup based on a detailed assessment of five key success factors: basic value, technology, execution, strategic relationships in the core market, and production and consequent sales.

A detailed assessment is carried out evaluating how much monetary value is assigned to the five key success factors. The startup valuation is the summation of those monetary values. This approach normally allocates up to $500,000 per success factor for a theoretical maximum pre-money valuation of $2.5 million. The Berkus approach may sometimes also be referred to as the stage development method or the development stage valuation approach.

Cost-to-Duplicate Approach

The cost-to-duplicate approach involves taking into account all costs and expenses associated with the startup and the development of its product, including the purchase of its physical assets. All such expenses are taken into account in order to determine the startup’s fair market value. The cost-to-duplicate approach comes with the following drawbacks:

• Not taking into consideration the company’s future potential by projecting financial statements of its future sales and growth.
• Not taking into consideration its intangible assets along with its physical assets. The argument here is that even at a startup stage, the company’s intangibles may have a lot to offer to its valuation, i.e., brand value, goodwill, patent rights (if any), and so on.

Future Valuation Multiple Approach

The future valuation multiple approach solely focuses on estimating the return on investment that the investors can expect in the near future, approximately five to ten years. Future sales growth and cost projections are made over the forecast period. A multiple is then applied to the appropriate metric in order to value the startup.

Market Multiple Approach

A market multiple is calculated using recent acquisitions or transactions that are similar in nature to the startup. The startup is then valued using the calculated market multiple.

Risk Factor Summation Approach

The risk factor summation approach values a startup by taking into quantitative consideration all risks associated with the business that can affect the return on investment. Under the risk factor summation method, an estimated initial value is calculated for the startup using any of the other methods discussed in this article. To this initial value, the effect, whether positive or negative, of different types of business risks are taken into account, and an estimate is either deducted or added to the initial value based on the effect of the risk.

After taking into consideration all risks and implementing the “risk factor summation” to the initial estimated value of the startup, the final value of the startup is determined. Types of business risks that are taken into account are management risk, political risk, manufacturing risk, market competition risk, investment and capital accumulation risk, technological risk and legal environment risk.

Discounted Cash Flow Method

The discounted cash flow (DCF) method focuses on projecting the startup’s future free cash flow. A rate of return on investment, called the discount rate, is then estimated. Since startups are new companies and there is a high risk associated with investing in them, a high discount rate is generally applied. The future free cash flows are then discounted back to present value.

e Commerce Business Models

Overview of eCommerce Business Models

The eCommerce industry has undergone significant change since its rise in popularity during the 1990s and early 2000s.? As the separation between offline and online has nearly disappeared, most companies have adopted some sort of hybrid or omnichannel approach to marketing their products or services.? This guide outlines the most popular types of eCommerce business models.

Given the wide range of business models and approaches, we’ve created this guide to help you quickly understand the various approaches, and think about how to best set up your own business, or how to?financially evaluate an eCommerce business using a financial model.

Below is an illustration of the main types of eCommerce business models. ?The three items highlighted in gold will be discussed in more detail.?

Marketplaces

The first main category in the top left of the diagram is marketplaces. These are the various places where sellers can list their products or services, with the marketplace operator providing a platform that connects buyers and sellers. The marketplace charges a transaction fee for its service. Classic examples include eBay (B2C and C2C), Amazon (B2C), Alibaba (B2B), and Fiverr. Marketplaces can expedite the buying and selling of both goods and services.

When building a financial model (there are various types of financial models) for a marketplace, it’s important to build the model starting with Gross Merchandise Value (GMV), which is the total value of goods and services transactions on the platform.? From there, the commission structure determines revenue for the platform, and costs can vary widely depending on the business.

In most cases, the sellers handle fulfillment (whether they pay for it themselves or charge the customer), but in some cases, such as “Fulfilled By Amazon (FBA)”, the marketplace will also take care of delivery.

From a financial modeling perspective, it’s important to clearly map out the revenue model and expenses in a logical and easy to follow way.?

Retailers

In the direct model, retailers are responsible for finding their own customers and have full control over the customer experience. The direct business model typically requires significant marketing spend and a means of driving traffic to the website. Unlike marketplaces that primarily just facilitate transactions, retailers often try to provide a curated experience for their customers and help guide them through a unique discovery process.

Retailers typically don’t own their own brands, and instead, sell other companies’ brands.? Given the pressure online retailers are feeling from both sides of the buying and selling environment (marketplaces offering the most competitive prices, and major brands now selling direct to customers), they are probably in the most challenging position of the eCommerce business models outlined in our diagram.

Brands

Brands are now using their own websites and social media accounts to sell directly to customers. A classic example of this is Nike, which has made its direct channel (the company website) a top business priority and expects it to be one of their largest revenue segments by 2020.

Brands are on the other end of the spectrum from marketplaces – they have the most focused selection, the highest level of customized experience, and the strongest connection with the customer. In comparison to other eCommerce marketplaces, they have a more limited selection, and also bear full responsibility for the marketing and fulfillment of their products and services.?

Winners and losers

There are pros and cons to each of the various business models, and while the size of the total eCommerce pie is still growing, there remains a massive divergence between winners and losers in today’s rapidly changing and increasingly global economy.

Online marketplaces and brands are best positioned to be winners, while retailers are most likely to be squeezed as they sit in the middle between brands and marketplaces.

At the?end of the day, it all comes down to the customer lifetime value versus customer acquisition cost to determine if the eCommerce business model makes sense for a particular business. The ratio of lifetime value to acquisition cost will largely be a function of Return On Ad Spend (ROAS).

The focus for marketplaces will be price, service, execution, and selection. The focus for brands will be connections and relationships with the customer, exclusivity, and experience.

From a financial modeling perspective, it’s important to think how about the eCommerce business you’re modeling will benefit or struggle from the issues described above.

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