How To Calculate The Valuation Of A Startup?
Undoubtedly, business valuation is critical for every business. However, it is notoriously a hard process. For startups with little or no revenue or profits or that are not publicly listed, startup valuation at an early stage is far more complicated than a mature business with steady revenues.
Startup valuation is the process of calculating the true value of a company. It provides insight into a company’s ability to use the new capital to enhance their profit and meet their customer and investor expectations. A startup valuation may account for several factors: the team’s expertise, business model, total addressable market, reputation, assets, performance, etc.
Startup valuation is not critical for business owners but investors too. It helps business owners decide the equity amount they have to pay to their investors in exchange for requisite funds and enables them to gain the attention of more potential investors. Moreover, it helps you to determine the resale value of your company. Apart from this, it helps investors and other venture capitalists understand whether they should invest in your company or not.
So, how to value a startup mathematically? In this guide, I will share detailed personal learning on startup valuation. So, without further ado, let’s get started.
How to evaluate a startup company?
Standard earnings multiple method: This method offers you excellent insights into free cash flow and how the stats will help improve the company’s value. When you use this method, all you need to do is value the company as a multiple of their EBITDA (earnings before interest, tax, depreciation, and amortization). In the e-commerce business, the multiple usually ranges between 5 to 8x the past three years’ average profit, but it may range between 8 to 12x for SAAS businesses.
Apart from the standard profit model, several other factors also play a vital role in deciding your company’s value. It includes previous debts incurred, the intellectual capital of the product or service, etc. However, the valuation can increase tremendously, especially for companies with some type of patent or proprietary technology.
Discounted Cash Flow Method (DCF): This method is great for those who still have yet to start generating earnings. It involves analyzing the cash flow the company will generate in the future and then calculating how they should use that cash flow that can benefit the company by considering an expected ROI return. After this, a discount rate is applied to the analysis. Usually, a higher discount rate is applied to the startups as there are huge chances that they won’t generate sustainable cash flow.
When you evaluate your startup value, you can have a meaningful conversation with the investors, which will further help investors to ensure that they are investing in the right company.
Cost-to-duplicate: This method is used when business owners and investors want to know the fair market value of their company. This method involves analysis of how much amount it would require to replicate the same company at another location from scratch. The idea is that an investor won’t invest more than it would cost to duplicate the business.
However, this method doesn’t elaborate on the future potential of a startup. So, this method is only suitable for early-stage startup valuation.
The Bottom Line
Startup valuation is equally important for business owners and investors, but valuation always gives you a rough estimate of your company’s value. So, you should use multiple methods to evaluate the valuation.
Also, it is a complex process. So, you should consider getting help from an experienced financial analyst, especially if you have never done it before. If you have any questions or I have skipped something, do let me know. I would be happy to solve your queries.
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