Myself and two cofounders have built an MVP and even brought in some revenue. It’s not a ton of money, but with more capital and employees we really feel we can multiply our revenue figure quite a bit.
None of us come from finance backgrounds, but we’re slowly working our way through our financial projections and want to be very careful with our valuation, because we’ve heard about how companies have been too aggressive and set themselves up for a down round in the future. We want to play this conservatively.
For a valuation, should we look at similar companies near us? How much weight should we give to our early revenue figures? What other factors are important to consider?
So far the most common valuation techniques I have come across are:
-The DCF (Discounted Cash Flow)
-TheFirst Chicago method
-Asset-Based Valuations such as theBook Valueor theLiquidation value
-Venture Capital Method: calculates valuation based on expected rates of return at exit.
-Berkus Method: attributes a range of dollar values to the progress startup entrepreneurs have made in their commercialization activities.
-Scorecard Valuation Method: adjusts the median pre-money valuation for seed/startup deals in a particular region and in the business vertical of the target based on seven characteristics of the company.
-Risk Factor Summation Method: compares 12 characteristics of the target company to what might be expected in a fundable seed/startup company.
I advise most startups to not place a valuation on their company. The only valuation that matters is the valuation of the lead investor in your series A round. I think it's better to wait until that investor values the company because that's the one that will matter. If you try to guess at it before then you're almost always either too high or too low. Convertible notes allow you to raise money without placing a valuation on the company... this way the company's valuation is set by the Series A investor, which as I said is the only valuation that matters.
Depends on why you want he valuation;is it for raising money-- or to go public- or just for your own amazement.If it for getting $ - call in a seasoned old hand business appraiser.
As I understand in ideal world you need to get money without need of valuation or to get fair valuation. I would suggest 2 general approaches. 1st is using convertible debt instead selling shares or options. This instrument is exactly used to avoid need of valuation in cases like yours too eraly. Second is to get funds from experienced reputable investor, which has their standards. Like Y Combinator " it will be investing a total of $120,000 into each startup for 7 percent in equity. It was previously investing an average of $17,000 for 7 percent, plus a safe that converted at the terms of the next money raised for another $80,000 ". "Safe" that mention here is also a financial instrument, you can find it's description by googling "safe vs convertible debt". But these exact terms are for seed stage. Plus you get experience, network and advice of investor. If you chose the proper one.
I love this question because it is so darn hard to answer! My dad used to say 'your worth whatever someone will pay for you!'. As cheeky as that sounds, it's hard to argue with... So, while you've done a masterful job of articulating the technical methods whereby you can value an entity, it is in fact more art than science.
Truth be told, people invest in people not companies. Ideas are 10 cents for 12. People who can execute are RARE - you wanna be one of them! Back to your question, any valuation/financial projection will be a fantasy - every pitch I have ever seen shows hockey stick growth. It's become a cliche.
I suggest that you just do the best you can. Even if you're not financially savvy, you can use your judgement to determine if the numbers make sense. If you're predicting a billion active users be month 18, you might want to rethink. But to tell an investor, I need half a mil to burn over the next X months with this use of funds and that will generate Y active users at Z positive cash, the answer will be clear. And hopefully compelling.
Then it will just come down to whether they LIKE you....
Congrats on your startup. I will try to answer to you based on my investment banking/M&A, private equity and entrepreneurial experience. I am myself currently engaged in a capital raising process for a luxury venture I launched a year ago.
I suspect if you are asking this question and you are not from a finance background, it is because you have been asked to come up with a valuation, most likely for a capital raising exercise.
First, investing in a business at an early stage is a risky thing to do and essentially it is about trusting the entrepreneurial team, often more than the idea. Be careful in protecting the idea specially if it can be replicated without you.
Second, assuming the valuation is to know how much of your company to give away to an external equity investor, your objective to negotiate the highest possible value so that you give away as little as possible.
Third, financial projections can be set to whatever you want and can back up. An investor will try to rationalise them and bring them down so he/she gets more out of his/her invested capital.
Fourth, valuing a business is never an easy task, and certainly not a science, and although you could try all the techniques, some are more indicated when you are a new venture with little cash. DCF gives you a theoretical intrinsic valuation but is highly dependant on your assumptions based on the discount rates and terminal value growth/exit multiple. Comps or comparable publicly traded company (market) multiples are irrelevant because a startup will never be comparable to a public company with years of existence. Prepaids or transaction multiple is relevant but might be difficult to find given your business probably has a unique selling proposition that distinguish it from others. Asset-based valuation is irrelevant for new business because it is a very conservative methodology that prevents from putting a value on the future: hopefully your business worths a lot more than the sum of it assets. The other methods are used by business angels/VC because it allows them to ask themselves questions about the risks/rewards of investing in you. They exist to bring your valuation down in a negotiation.
Fifth, do not mix valuation and pricing. Valuation is what your business is worth based on assumptions, including the purpose of the exercise. The price is the number someone will pay for it, given the information at hand and his/her personal will to invest.
Sixth, you can also value the company based on how much founders contributed to build it (cost of opportunity, salary not paid, deals brought to the table thanks to your network, cost of your education/training to be able to do this job, personal network...).
To put it in a nutshell, try the method that best works to your objectives and you can back up during negotiations.
Hope this helped. Good luck!
Hi Shakoya. Congrats on you MVP launch and sales. As the startup is in such and early stage I will do all of them and get an average (it is a good exercise and doesn't take that long). I will try to make more and more sales before I raise some money so you can have higher valuation and keep a bigger percentage of the company (also be careful of how much money you raise, do a burn rate/FCF projection). As an investor I will be more interested in the market potential and future projections based on your initial numbers (I will concentrate on that). Good luck!
My preference is not to value the company until it is absolutely necessary to do so. While it is a good ego-boosting, it has no real value at an early stage of a company. Even for early stage investment, more and more are using convertibles and similar instruments to avoid this meaningless valuation exercise.
The only time it makes sense is if you build your startup for a well define market, which can be well projected. This is more often happens with traditional type of business (making beds for local hospitals for instance) and not in the more recent companies we define as startups
Wow. How about something simple like, is there free will?
There is no rule. This is a negotiation. What will someone pay?
Valuation generally gets higher as you get to revenue and have reduced some of the risk. You are entering a sweet spot for raising money. The more clients and the more revenue, the better you will do.
Valuation generally begins with two things: the team and the idea. Some investors value the team more highly and vice versa.
Valuation depends on trends. Are you in an industry that is currently "in" such as AI?
Valuation depends on perceived growth. While no one will believe your business plan, they will have an idea of what kind of growth they expect and therefore how they should value your business.
I could go on and on, but you get the idea.
When I have raised money for startups, I have taken the following general approach;
Go to a financial source - banker or investment banker or VC - and see if you can get access to deals that have been done. Look at those that have characteristics closest to yours and see what their valuation parameters were.
Go to a VC that you know and have an informal chat. Ask them what they think the general parameters would be.
Actually make a presentation to a VC and see what they say. (Be careful. If they are interested, they will know it is a negotiation and may start on the low side. Having a bidding war among multiple potential investors is wonderful, but not to be expected.)
Interesting question with no one right answer - at least in the absence of a much closer look of your business.
I would venture to guess that asset-based methods, such as book value, would likely not be very relevant for most startups discussed in this forum. Book value is more relevant for mature "physical" businesses, simple patent plays and, generally, any business where good will, brand value and other intangibles are not core to the value of the business. Book value can establish a lower bound for your business, but likely a very low one (more on this further on).
Transaction comparables could be very effective as they essentially anchor the value of a business to that of another business whose value has recently been established on the back of a market transaction. This approach too has its limitations, however. No two business - even very similar ones - are alike and even small tweaks in underlying business parameters can result in significant differences in valuation. That said, I would keep this in the tool bag and give it a go, if comparables are available for your business.
DCF and VC multiples are essentially the same thing: you attempt to establish a present value of future cashflows (where cashflows can include exit/sale price) by discounting all future cashflow events to today by an appropriate discounting factor (i.e. multiplying with a number less than 1). Call that discounting factor the VCs ROI or cost of risk or market opportunity cost or whatever you like, it essentially serves the same purpose, to bring forward value to today appropriately adjusted for uncertainty. This too is a calculation that is worth doing in establishing a value for your business.
So you have DCF/ROI and market transactions as two things to try.
The more helpful exercise in my opinion is establishing value bounds, upper and lower, although the lower bound is the more important one, in this case: a value that you can confidently defend as a minimum or near-minimum for your business. You can establish lower bounds for both DCF and market transactions by stretching uncertain parameters in the valuation to defendable limits.
For example, for your lower bound value you may want to discount future sales to a point that you think is very likely deliverable, based on current performance and the performance of peer businesses. Or you can strip away or heavily discount some of the less robust streams of revenue you expect of the business.
If you establish a non-trivial (i.e. not stupidly low) lower bound for the value of your business you can at least say "my business is - almost certainly - worth at least this much" and build from there.
Hope this helps
The various methods of valuation that you suggest are all sound but most business brokers will tell you that you can buy most small, operating businesses for 3x next years earnings. If you are valuing the business to raise equity, then any private company's stock is based upon the price that the market will pay. That is why many small companies offer preferred when they can afford to pay a dividend or a royalty where appropriate. I don't favor valuations for private companies. Investors want either income or an exist strategy.