If you’ve been in the startup world for any length of time, you’ve probably heard the advice, “Valuing your startup is harder than investing your money.” Or maybe something a little more colorful (like, “valuing your startup is easier than buying a house.”), but it all amounts to the same thing: valuing your startup requires identifying its value proposition, understanding what kind of return you can expect from that value proposition, and deciding whether or not that return is worth giving up some control over your company. The process doesn’t get any easier once you launch.
What is startup valuation?
A startup valuation is the market value of the startup, based on a variety of factors. Startup valuation is a process that every entrepreneur must undergo when raising capital.
Valuing a startup before it generates income can be a challenging job. There are numerous factors to examine, ranging from the management team and market trends to the product’s demand and the associated marketing hazards.
Financial analysts have access to a variety of different approaches that can be utilized in the process of startup valuation. Therefore, we will explore some prominent startup valuation approaches. In the broadest sense, startups are new business enterprises founded by an entrepreneur. Typically, they concentrate on developing original concepts or technology and offering them to the market as new products or services.
How to value a startup
The first step in valuing your startup is by identifying its value proposition. This is the “why” behind your product/service and it’s the reason you exist. Your value proposition should explain what your product/service does and why it’s beneficial for users. Startups are all about solving problems and making life easier for users, so it’s important to have a value proposition that explains why your product/service is unique, necessary, and helpful for its intended audience.
Define your product/service and your market
Once you’ve got a sense for what your product/service does, you can move on to the market. This is the “how” behind your product/service, which is how you’ll be able to acquire customers and make money. A great way to go about this is to find a market that’s near, yet far away from you. Markets like health and medical, financial services, and even tech markets are more difficult to value than markets that are more nearby (i.e. closer to you). When it comes to the market, you’ll want to focus on the need for your product/service and the benefits your product/service provides. For example, if your product/service is a software that helps startups track their growth and profitability, and the market is businesses looking to increase their growth and profitability, then your value proposition would be: “If you use this software, you’ll be able to track your revenue, expenses, and profit and see how your business is doing for you.”
Different startup valuation models
The Berkus Approach, devised by American venture capitalist and angel investor Dave Berkus, focuses at evaluating a start-up firm based on a rigorous study of five critical success factors: Value, technology, execution, strategic ties in its main market, production, and sales.
The Cost-to-Duplicate Approach considers all starting and product-development expenditures, including asset purchases. All initial expenses are considered while calculating its fair market value.
Future Valuation Multiple Approach
The Future Valuation Multiple Approach only focuses on calculating the return on investment that the investors might expect in the near future, say five to ten years. The startup is valued based on projected sales, growth, cost, and expenditure predictions, etc.
Market Multiple is a popular startup valuation strategy. Market multiples work as expected. Recent acquisitions similar to the startup in question are considered to determine a base multiple. Using the base market multiple, the startup is valued.
Risk summarization method
The Risk Factor Summation Approach assesses a startup by quantifying all risks that affect ROI. The risk factor summation approach calculates a startup’s initial value using any of the other methods in this article. The original value is adjusted based on the positive or negative impact of various business risks.
The DCF Method projects the startup’s future cash flow movements. A “discount rate” is assessed to determine the projected cash flow’s value. Startups are risky, hence a large discount rate is imposed.
To value your startup, you must understand its value proposition, the return you can expect from it, and if that return is worth giving up control. Once you understand your startup, set a price and see what occurs.
“Valuing your startup is tougher than investing your money,” you’ve probably heard. Valuing your startup includes recognizing its value proposition, determining what kind of return you can expect from it, and deciding if that return is worth giving up control of your company.