Why We Need Startup Valuation and How to Do It

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Startup valuation is vital for investor fundraising and proper projection for the selling price of your business equities. At the initial stages of running your business, you may not have sufficient capital for daily company operations, procuring goods and services or paying your team. However, you can solve this problem and make your business sustainable by performing an accurate startup valuation. With a good valuation, you can approach venture capital (VC) firms and angel investors or submit your proposal to business incubators. These institutions will provide you with the capital required to run and sustain your venture in the future. Your startup valuation should provide a clear insight into how best you will use the funding appropriately, grow and sustain your business, and meet your investors’ requirements.

Factors to Consider When Performing Startup Valuation

  • Your sector or industry
  • Market forces, i.e., demand and supply of your goods and services
  • Projected amount of capital needed to run your business
  • Your business model
  • Track record of your business team members
  • Market competition
  • Business goodwill

How to Perform Startup Valuation

Berkus Method

The method was established by an American angel investor Dave Berkus. The Berkus method uses qualitative and quantitative elements to assign specific amounts to each startup’s progress. When using this method, you consider the following elements:

  • The basic value of your venture or the sound idea
  • The business prototype that incorporates proper technology to minimize risks
  • Professional management team to reduce business execution risks
  • Strategic business relationships to minimize your market risks
  • Product sales or rollout that minimizes your capital or financial risks

When performing startup valuation using this method, conduct comprehensive tests on the five elements to accurately determine the value of your venture.

Venture Capital Method

It provides both pre and post-money value of your business by estimating your expected capital and terminal value returns. The terminal value projects your business value at a future date. When conducting startup valuation using this method, you need the following pre-money calculations:

  • Startup valuation calculation in a harvest year
  • Forecasted ROI of your investment

Consider the price to earnings ratio (P/E) in your calculations. The ratio projects your business share price compared to the prevailing per-share earnings. When calculating the business terminal value, you need:

  • Industry or sector P/E ratio
  • Forecasted business revenue for the harvest year
  • The forecasted business profit margin of the harvest year

The formula for calculating the terminal value:

  • Terminal value = Forecasted Business Revenue x Forecasted Business Margin x Industry P/E ratio
  • Terminal value = P/E ratio x Business Earnings

When computing your second pre-money business valuation, consider the following:

  • Business investment amount
  • Return on Investment (ROI)

When computing the pre-money valuation, use the following formula:

  • Pre-money valuation = Business Terminal Value/Return on Investment (ROI) – Business Investment amount

Market Multiple Method

Venture capital investors mostly prefer this valuation method. It provides a clear projection of the startup’s value in the market. When calculating the startup valuation of your venture using this method, use the data from the acquisition of a similar business as yours in the industry. The process involves forecasting the potential growth of your business and the projection of the assets and profits as the business matures. Venture capital investors are willing to finance a business if the market multiple indicates that it will generate assets and profits. A challenge associated with this method is how to find past business transactions of a similar business in an industry within your locality.

Discounted Cash Flow Method

When using the discounted cash flow method, the valuation of a startup is determined by estimating the future cash flow amount. If you want the present value of your startup, compute the discount rate value from the rate of Return on Investment (ROI). When you add all the discounted cash flows, you will get the true value of the startup valuation of your venture. However, this method uses market assumptions and is not commonly preferred by business startup analysts. It mostly depends on the analysts’ knowledge and experience in predicting the performance of startup ventures based on the current market conditions.

Risk Factor Summation Method

The method provides the valuation of a startup by considering the market risks that might affect the business’s Return on Investment (ROI). It involves two steps of startup valuation. At first, a startup analyst uses any of the valuation methods. After coming up with a business valuation, an analyst then adjusts the valuation by considering all the market potential risks.

Conclusion

When performing your startup valuation, consider similar ventures in your area within your business industry and check their business appraisal. Their valuation will provide you with a clear picture of your startup’s expectations. However, avoid sticking to one particular approach. Using several methods lets you calculate an average and get a more accurate value. Since startup valuation involves a lot of computations and market analysis, it is best to hire a professional. Wiley Financial has a track record of helping startup ventures develop a precise valuation of their businesses. The company is accredited, has certified valuation analysts, and has a wide experience valuing startups in different industries. Contact us today for your startup valuation.