How to value your startup is something that every entrepreneur should know. However, figuring out how much your startup is worth is not an easy task. Because commercial success remains in infancy in their early stages, their values will be based on assumptions about the future at these early stages. Furthermore, future forecasts are often unreliable. Because of this skepticism, investors often believe that everything will take way longer and cost twice as much as they initially envisioned.
To obtain capital and produce liquidity for their investments, entrepreneurs and investors alike must place value on startups. Let’s evaluate everything today. So, the purpose of this article is to give some advice on how to value your startup to be able to value it and raise money to fund it.
What is the startup valuation?
Let’s get to the basics before finding strategies on how to value your startup. The process of evaluating a startup comprises determining the startup company’s worth. Valuation can get difficult for startups with little or no income or profitability and unpredictable futures. Therefore, it is critical to employ startup valuation methodologies when valuing them.
Pre-revenue investors would choose a lower valuation that offers a higher return on investment, whereas business owners would want a higher valuation. Consequently, we would want to evaluate, how do pre-revenue startup valuations stack up against mature business valuations?
The actual data and numbers of a mature, publicly-listed company, as opposed to a startup in its early stages, will be more readily available. The ability to assess the worth of a firm is made simpler by a consistent stream of income and financial data. Even though most startup valuation methodologies do not include earnings, taxes, and amortization, startup owners will be able to factor in other essential elements throughout the process.
How to value your startup: the three-step process
1. You are exactly what the market thinks you are
The question of “how to value your startup” might get a bit complex from time to time. As long as investors tell you that you’re worth $1 million, you are. You could believe it’s worth a lot more than it really is. Because your business may have more than $1 million in liquid assets, more than $1 million in receivables, more than $1 million in sweat equity, or a combination of these factors, you may even feel that it is worth more. The market value will have to be accepted if you cannot secure capital for your firm with a valuation.
The opposite is sometimes true, though. Instead of professional investors, you may be able to obtain money from family and friends, which indicates that your firm has been over or undervalued. In most cases, it’s overvalued in this scenario. Consider the following scenario: it doesn’t necessarily follow that future investors will pay more than $20 per share if you can convince your father and wealthy aunt to invest in your company, even if it develops and prospers.
2. It is also possible to determine your own value in the marketplace
Although this seems to counter the argument about how to value your startup, it is possible to tell the market how much your business is worth. It’s not by accident that investors estimate your business to be worth $1 million. By definition, startups don’t have a history of making money to figure out how much they’re worth. Therefore, the responsibility for developing a method for valuing the firm based on comparables and financial predictions falls on the shoulders of the entrepreneur.
Investigate the market value of comparable firms in your sector and geographic location. Business valuation websites such as BizBuySell and BizQuest can help you determine how much businesses are selling for in your industry. You should consult accountants and attorneys if you have a high-tech or high-growth business to help you estimate the market rate for similar firms at your stage of development. In our experience, lawyers tend to overvalue companies. On the other hand, accountants tend to undervalue startups. Therefore, you may want to consult with both before deciding whether to proceed.
Predictions on the future financial situation
Even though forecasting income at a startup is notoriously tricky, you’ll need to do so to evaluate the value and, ultimately, justify your company’s price. Consider the following example: if you’re starting up a clothing business, your value and financial predictions will most likely be lower than if you’re starting up a speculative biotechnology company.
3. You aren’t truly worth anything until you start making a profit
It’s unlikely that your business is worth a lot if you’re not making a profit at all. That is, it lacks the liquidity that a profit-generating company would have. Due to a lack of business buyers to match the number of sellers, it’s much harder sell many enterprises today. Selling an underperforming firm is almost impossible for the same reason.
As a result, startups have a challenging time determining their value. Because it takes time for new firms to become successful, the key to determining the value of startups is to keep an eye on the future. Make a timeline for when you’ll be profitable, and then plan accordingly. The value of a firm with a longer path to profitability is generally lower than that of a business with a shorter route to success.
Assessing similar firms’ profitability allows you to evaluate their market worth. And this must be done considering the stage at which the interested firm is in. If it is at a different stage compared to your firm, historical records might help. Based on things like how likely it is that the company will make money, how long it will take to get out, and how good the management team is, a company worth $5 million when it is profitable will be worth a fraction of that amount when it starts out.
How to value your startup using valuation methods?
Financial analysts may use a variety of startup valuation methodologies to determine the worth of a company. Let’s take a look at some of the most frequently utilized approaches for assessing the value of startups.
1. How to value your startup using the Berkus method
American venture capitalist and angel investor Dave Berkus describes how to value a startup enterprise by conducting a thorough analysis of five critical success factors:
1) Basic value
4) Strategic relationships in its core market
5) Production and subsequent sales
In this procedure, the startup carries out a thorough evaluation to determine how much value the five main success factors contribute to the overall worth of the firm. The startup is valued in accordance with these metrics. This approach is also famous as the “Stage Development Method” or the “Development Stage Valuation Approach,” and it is based on the work of Berkus and his colleagues.
2. The Cost-to-Replicate Methodology
This is also another helpful approach to make use of when you are looking for an answer to “how to value your startup.” The Cost-to-Duplicate Approach entails accounting for all costs and expenditures related to a company’s startup and development of its product. And this also includes the acquisition of any physical assets required for the endeavor. Accordingly, you can calculate the startup’s fair market value by considering all of the startup’s expenditures. There are a few problems with the cost-to-duplicate method:
- Inadequate attention is given to the company’s future potential via projected claims of future sales and growth.
- This is without taking into account its intangible assets as well as its tangible assets. There is an argument here that even in the startup stage, the company’s intangibles, such as brand value, goodwill, patent rights (if any), and so on, may have a lot to offer for their worth.
3. How to Value Your Startup Using the Risk Factor Summation Approach
Using the risk factor summation approach, you may determine the worth of a firm by taking into account all of its risks, including those that might negatively impact its return on investment, in numbers. Using any of the other approaches covered in this article, one can use the risk factor summation method to establish an estimated initial value for a fledgling company. The consequences of various sorts of business risks, whether positive or negative, need consideration when calculating this initial value. And then, an estimated value is either removed from or added to the original value, depending on the influence of the risk in question.
When all possible risks are taken into account and the “risk factor summation” is applied to the original estimated value of a business, the final assessed value of the firm is established. Management risk, political risk, manufacturing risk, market competitiveness risk, investment and capital accumulation risk, technology risk, and legal risk are some of the company risks that are taken into consideration.
Trenetic’s final thoughts on how to value your startup
Make sure you don’t forget that one day, you’ll have to live up to the expectations of your investors, even if you think your company is worth the most. Also appealing is changing your business plan to increase the value of your startup. At the same time, do not go so far as to change the entire business idea, as this may cause the business to fail. Be cautious about overestimating the value of your company based on erroneous assumptions. If your investors have governance rights, such as positions on the company’s board of directors, this will only make your job more difficult.
When it comes to determining the value of their fledgling company, entrepreneurs must think like artists. Creating a successful company requires both the left and right sides of your brain to work together. You will also benefit from reading our post on how to raise funds for a startup.