As a business owner, you should probably become familiar with startup valuation. We will share various startup valuation methods that you can use to gauge the worth of your business.
Startup Valuation Challenges
Calculating startup value can be challenging. This task is much easier for older businesses that can simply use the EBITDA formula:
EBITDA = Net Profit + Interest +Taxes + Depreciation + Amortization
But if you are just starting your business, it might not have those components yet. Furthermore, finding startup value is another new skill to learn.
You are already busy learning all sorts of business-related concerns and trying to keep track of new terms and jargon. Is finding the value of a startup really worth the additional time and effort?
We would argue that it is!
There are several circumstances that require knowing the value of a startup. These include:
- Applying for business funding;
- Selling your business;
- Working with investors to speed up your company’s growth.
According to Medium, your startup’s value should be calculated if, “the business model has high sales growth expectations, high margins, high revenue visibility, high customer stickiness, large market size, flexible pivot options and most importantly, a top-class team.”
Startup Valuation Methods
There is more than one way to figure out the value of your startup. In fact, Forbes claims there are, “dozens of valuation methodologies.”
We are going to teach you a few of those startup valuation methods right now.
Comparable Pricing Method
Simple and straightforward, this method might be a good choice if you don’t have much experience with calculating startup value.
All you have to do is use a similar company’s value to get an idea of your own company’s worth. Although not the most accurate method, it will at least give you a place to start.
Compare your startup’s success in certain areas with the level of success other startups have attained. These areas could include:
- Your product’s potential to succeed;
- The experience level of your team;
- Your company’s ability to handle competition;
- And more!
If your startup scores higher than other businesses, it probably has a higher startup value than your competitors do.
“Cost to Duplicate” Method
How much money would it take to duplicate your startup? This amount is probably close to your startup’s current value.
However, this method is focused on costs and doesn’t factor in future growth, sales, and ROI. This may result in valuing your business at an amount that is lower than what it’s actually worth.
Asset-Based Valuation Method
This startup valuation method makes it especially easy for investors to gain an understanding of a startup’s worth. Asset-based valuation requires taking each asset’s initial cost and adjusting it for impairment costs and depreciation.
When using this startup valuation method, you need to:
- Add the value of each of your assets together.
- Subtract all liabilities from total assets.
Keep in mind that the end result only reveals your startup’s current worth because this method does not take future growth and success into account.
Utilized by David Berkus, this startup valuation method relies on estimates. Berkus claims that most startups don’t come up with an accurate forecast, so he shortened the estimation process.
Berkus “assigns a number, a financial valuation, to each major element of risk faced by all young companies.”
Those elements include:
- The likelihood of the product or service attaining success and being accepted by consumers;
- Producing a product prototype that minimizes risks associated with technology;
- Having a quality management team to help minimize risks;
- Developing relationships that reduce risks associated with the competition and market;
- Future plans for sales and product rollout.
The highest number each element can be assigned is $500,000, meaning your startup’s value could reach as high as $2.5 million.
Risk Factor Summation Method
This next startup valuation method reviews 12 different categories. These categories include:
- Stage of the business
- Legislation/political risk
- Manufacturing risk
- Sales and marketing risk
- Funding/capital raising risk
- Competition risk
- Technology risk
- Litigation risk
- International risk
- Reputation risk
- Potential lucrative exit
The performance level of each category is rated on a scale from extremely poor to exceptional, with good, neutral, and poor ratings falling in between. Each category’s rating determines its value.
The value that can be assigned to each category could be as high as $500,000, as low as negative $500,000, or anywhere in between.
Discounted Cash Flow (“DCF”) Method
Investopedia says, “Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment based on its future cash flows. DCF analysis attempts to figure out the value of a company today, based on projections of how much money it will generate in the future.”
Basically, this startup valuation method requires an approximation of future cash flow in order to calculate startup value. These predictions may or may not come true.
This method is a little more complicated than the options previously described because it involves a series of formulas. To make it even more challenging, a minor mistake could result in major inaccuracies.
However, when done correctly, this approach is more accurate than some of the simpler methods.
We should point out that if your startup is still new and lacks adequate data regarding cash flow, this method probably isn’t the best choice for you.
It’s a better option for older companies that can employ past data to make accurate forecasts of future cash flow. But even those companies still make mistakes when using DCF.
Which Startup Valuation Method Should You Choose?
That depends on the type of business you have. Try to pick one that will make your business look as good as possible.
Here are some more tips that will help you decide which method to use:
- Refer to industry standards;
- Consider your company’s current phase;
- Take the pros and cons of each method into account;
- Figure out which method investors are most likely to favor;
- Make sure you can perform the calculation correctly so that you will get accurate numbers. This may require using a simpler method if you don’t have much experience with startup valuation.
Startup valuation is crucial for investors because it provides them with useful information that enables them to make wise investments. So if you want to work with investors, you need more than just a product-market fit.
You will also need to calculate your startup’s value. But don’t fret.
This doesn’t have to be overwhelming. Simply consider which method would be best for your particular business and then carry out the necessary computations.
Once you’ve done that, you will know your startup’s value. This should improve your odds of getting an investor’s attention.