How Startup Valuation works?
Meaning of startup valuation
How do you determine value for an enterprise started a week or a month ago? , Will there be any company value at such stage?, Any enterprise at start has to incur lot of investments for its business and returns for it may not be stable or it may not have any return, So can we say present value of such startups is zero as selling them now will not fetch you any money?
Then what is valuation of startups?
The answer is simple, these startups are not valued at their present value but their future earning capacity, their potential for growth, Quality of products or service they are going to offer, future contracts and agreements. These are valued using various approaches discussed in the following paragraphs –
Things to consider before startup Valuation
Knowledge of other business in the Industry – you are not alone in the race, the speed and pace at which other entities are operating in the market affects your valuation, thus having knowledge of similar entities in the market is of vital Importance
Usage of Multiple approaches – A single approach may not be indicative of fair value of startup, as values are based on lot of assumptions and guesswork, average value of various methods should be chosen.
Unbiased and relevance – Methods should be applied considering if such method can be used for a particular Industry, it must be relevant to particular kind of industry and also be unbiased in its approach.
Start up valuation techniques
Venture Capital Method
As name suggests it is used for valuing new ventures, the valuation is based on the following –
Terminal value = Value expected at the end of startup stage (can be computed through discounted cash flow or multiples approach)
Discount factor = return on investment
Post-money value = terminal vale/Discount factor
Pre-Money value (Company value) = Post money value – Investment
Market Multiple Approach
It means what Market is ready to pay for the company, generally multiple is based upon the value of a similar company adjusted based on different characteristics. A multiple is multiplied with average earnings and company value is determined.
Discounted cash flow Method
It is Favorite method of Investors for valuing business if your startup has started generating income and has future earnings scope, it represents forecasting your future earnings and discounting your Free cash flow to firm (FCFF) using expected rate of return. A higher discount rate is preferable for startups as there is high risk that entity may fail to generate those projected cash-flows.
New Startups generally have few assets to gear up the business, the market value of all such assets and value of intangibles together constitute value of business.
Value based on human resource
Human resource are the most valuable resource the organization has, success of any venture depends highly on how professional and skilled your employee is. Under this approach value is assigned to all paid professionals and employees and value of business is computed.
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