Top 5 Methods of Startup Valuation [2024]

Wondering how to value your startup company??

Or what are effective methods for valuing startups??

Business valuation has never been straightforward for any company - emerging or mature. For startups with little or zero revenue figures and uncertain future, the charge of valuation often remains challenging. For mature and listed organizations with proven track records of earnings, prospective investors can value them as a multiple of Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) or using other industry-relevant options. But in the case of startups, it's harder for venture investors to value a newly launched company that might be many years away from making actual sales.

Startup valuations emphasize the company's ability to use funds for future growth, fulfill customer needs and investor's expectations, and disrupt the saturated market environment with innovative products and solutions. In the modern business landscape, startups are now not only hitting $1 billion or more to strengthen their positioning as Unicorns but many successful startups with founders' clear vision and ability to disrupt global markets are also categorized as Decacorns with a startup valuation of $10 billion and Hectocorns with over $100 billion of valuation figures.

While these figures seem overwhelming, a startup valuation is a critical process that considers factors like the team's expertise, product, startup assets, proposed revenue model, addressable market, competitor performance, and market response in the last few years.

What is Startup Valuation??

Startup valuation is a complicated process of evaluating a newly emerged or emerging company's potential, capacity, and prospects. Startup valuation is determined based on the dollar price per share of equities. This approach disregards the requirements of historical data and financial statements to estimate future growth possibilities in an ever-changing business environment.

The valuation of startups can simply be calculated based on core business ideas, product prototypes, the founder's expertise and vision, minimum viable product, initial sales data, or any other factors. Because of the absence of sales figures and a track record of consistent growth like those found in mature organizations, startups can't be valued on conventional valuation methods. The startup valuation methods often involve the potential of future growth and related market dynamics.?

Related: What Are Blue Chip Stocks? Features, Advantages, & Disadvantages

Top 5 Valuation Methods for Startups

1. Berkus Method

A renowned venture capitalist, Dave Berkus, created this valuation technique for pre-revenue startups. This method focuses on valuing a startup company based on its key drivers, including business ideals, product prototypes, strategic relationships, specialized executive teams, technology, and the startup's innovative products. The method begins with the assumption that the startup will hit $20 million in revenue in the first five years. To further evaluate the feasibility of this projected value, the investor adds funds up to $500,000 across the given value drivers. A potential estimation may look as given below:

Business Idea: $400,000

Strategic Relationship: $500,000

Specialized Executive Team: $400,000

Product Prototype: $300,000

Technology: $400,000

Since the investor aims for the company to achieve a $20 million valuation in the next five years, the next step focuses on evaluating these value drivers' capacity to increase the startup's worth within the specified time frame.

2. Discounted Cash Flow

Another method of valuation for startups is discounted cash flow, which is suitable for most startups, particularly those still many years away from hitting market sales. Startup owners work closely with market analysts or experienced investors to forecast how much cash flow the company will generate and then use the discount rate or expected rate of return on investment to determine the actual worth of that cash flow.

Normally, the higher discount rate indicates a higher risk in the investment, requiring startups to achieve better growth rates in the future. The only drawback with this valuation method is that the quality of DCF depends upon the analyst's ability to forecast future market conditions and develop appropriate assumptions on long-term trends and growths.

Related: 5 Key Strategies for Expanding Your Brand Internationally

3. Comparable Transactions Method

The comparable transactions method is among the popular valuation methods for startups because it can adequately answer the "what was the acquisition amount for startups similar to mine?" For example, assume a fictional SaaS company, Ship2Go, got acquired for $20 million, with its mobile app and website user count of 500,000, indicating $40 per acquired user. Your shipping startup under the same segment has a combined user count of 124,000, which would give a valuation of around $4.96 million.??

In favorable market conditions, it may be normal for SaaS startups to generate between 5x to 7x compared to the previous year's net revenue. Analysts must consider various factors in ratios or multiples with any comparison method to check the differences between the two companies. For instance, in the case of SaaS companies, if you find that the acquired company has proprietary technology and your company does not, you can prioritize a multiplier on the lower end of the given range.

4. Scorecard Method

Another valuation method for pre-revenue startups, the scorecard method, works by comparing your startup with others in the same industry but with some added criteria. The first step to valuing startups under this valuation method is finding comparable companies' average pre-money valuation. Then, your next step is to evaluate how your business drivers stack up according to the criteria.

Size of Business Opportunity: 0-30%

Team Strength: 0-25%

Product or Services: 0-15%

Competition Strength: 0-10%

Marketing, Sales, & Partnerships: 0-10%

Urgency of Additional Investment: 0-10%

The next step under this method is to assign a percentage figure for each quality. Typically, you can assign a par (100%), below average (<100%), or above average (>100%) figure for each assigned criteria. For instance, if you believe your startup has a complete, fully trained, specialized team of developers and marketers compared to some of your rival businesses, you can assign a 150% score for team strength. The same steps need to be performed for each stage. Here is what a completed comparison will look like.

Say you have a $3 million pre-money valuation of one of the comparable companies. You need to multiply the base valuation, which is $3 million, with a total score of 1.16 to get $3.48 million.

Related: How Electric Vehicles Are Changing the Tyre Industry

5. Venture Capital Method

The venture capital method is a go-to resource for venture firms to evaluate the valuation for startups. This valuation method is an appropriate tool to figure out the pre-revenue valuation of the company. It can also reflect the mindset of investors aiming to leave the business in the coming years.

Under this startup valuation method, there are two formulas:

Anticipated Return on Investment = Terminal Value ÷ Post-Money Valuation

Post Money Valuation = Terminal Value ÷ Anticipated ROI

To use this method, you must determine the startup's terminal value or the expected selling price once the venture capital firms invest in the company. This figure can be calculated using estimated revenue multiples for relevant industries or the price-to-earnings ratio.

Next, figure out the anticipated ROI, assuming 10x, and put it into the formula above to calculate post monetary valuation of the startup company. To get a startup's pre-money valuation, subtract the investment amount you are looking for from the post-money valuation.

Pre-Money Valuation = Post-Money Valuation - Investment Amount

How Do Venture Investors Evaluate Startup Valuation?

There are several factors that individual or institutional investors look for when investing in a startup, such as follows:

1. Growth Potential: Unlike mature organizations with slow growth, newly founded startups have the potential for high growth and market disruptions. Companies with such feasible possibilities are more likely to get the attention of venture investors.

2. Revenue Streams: Startups with high revenue tend to be more valuable. However, if the startup is still many years away from launching products or services in the open market, the VCs look for product prototypes before investing in these companies.

3. Revenue Model: A startup revenue model should be clear, feasible, and scalable. Investors look for better and consistent returns on their investments. Hence, those startups that fail to deliver a clear roadmap to build consistent revenue may struggle to attract adequate investment.

4. Founder & Technology Team: In the age of technology, investors are prioritizing funding startups of those founders who are honest and have a great sense of building a great business. Some startups with innovative and cutting-edge technologies have also attracted funding recently.

5. Funding Stage: The capital raised during the pre-seed funding stage affects the valuation at which the seed funding and series A, B, and C funding must be raised.

Simplify Your Startup Valuation Process

The increasing number of startups and fluctuating market conditions highlight the critical need for accurate startup valuations. For founders, obtaining a valuation estimate is essential, as it provides a solid foundation to demonstrate the actual worth of their company to potential investors. A comprehensive valuation report plays a significant role in shaping a long-term capital-raising strategy.

It is important to recognize that no single valuation method can accurately assess a startup's value in every situation. Instead, leveraging a combination of various valuation approaches is essential to arrive at a fair and realistic assessment. This multi-faceted strategy ensures that founders can present their businesses in the best possible light, enhancing their chances of securing the necessary investment. Ultimately, a well-informed approach to startup valuation is key to navigating the complexities of funding and achieving long-term success.

Suggested Posts

What Is SEO Copywriting, & Why Does Your Business Need it?

What Are the Benefits & Challenges of Mortgage Loans?

8 Reasons Why Companies Hire Freelancers