Methods to value your early-stage startup
To succeed in today’s rapidly changing business environment, organizations must focus on developing and achieving a high valuation. Early-stage businesses, in particular, necessitate a more precise valuation that takes into account a variety of different aspects. You need to know how to properly value a firm in your business plan if you want to make money. Isn’t it?
Now comes the million-dollar concern: Can these initial investors evaluate a business?
Business appraisal is a monumental effort in and of itself. It’s much more challenging to value an early startup because revenue is typically low or non-existent, especially when factoring in the costs of entrepreneurship. As a result, before making an intelligent investment selection, investors analyze various elements such as momentum, pre-valuation sales, market environment, and so on. Because each startup has a business strategy, the founders must conduct a thorough valuation that informs both the investor and the startup about its value.
In such a challenging environment, fundraising is critical for smoothing out the kinks in operational processes. However, to encourage investment, entrepreneurs must go through a thorough valuation method that enables investors and the startup to make informed decisions.
The most important considerations for early-stage investors
Startups must determine the entire quantity of funds they require to invest from independent bodies such as seed funding, venture capitalists, or a group of shareholders. Simply put, startup valuation is determining the value of a company or startup idea. Therefore, one of the most important aspects of any financing strategy is startup valuation.
Investors swap a portion of the company’s stock when they invest in a startup. It is when the importance of startup valuation becomes apparent. Essentially, the valuation process eliminates the guesswork and delivers the startup’s estimated worth.
Given the market needs and trends, investors are eager to invest in businesses related to a hot field. The post-pandemic environment, for example, has resulted in an exponential increase of early-stage firms in health tech, digital economy, logistic support, systems integration, food tech, and a variety of other fields. In addition, the investor examines the business strategy for revenue sources and sustainability. Furthermore, before determining the startup’s worth, investors check for client traction and the likelihood of recurring business.
New entrepreneurs frequently lack experience in judging startups. For example, some founders cite a significant sum to investors even when they are in the pre-revenue initialization step. Simultaneously, even if they have a successful idea and the ability to revolutionize the market, few founders estimate a lesser sum. Therefore, understanding how to calculate the valuation of a startup that is effective in the valuation process is important.
In order to conduct a valuation, Professional valuation analysts use different methods depending on the type of company they are working with. For early-stage startups, there are 7 valuation methods that are commonly used in the valuation process.
Valuation methods are essential and recognized based on firms in the pre-revenue period. However, these businesses frequently lack complex data or metrics to establish their valuation. As a result, predefined valuation procedures are required.
The following are the most common startup valuation methods:
1. Berkus Method
The Berkus Process, named after notable American angel investor Dave Berkus, is a straightforward method that many investors use when determining the worth of a startup. Five essential parts of the fledgling company are valued at $0.5 million using this strategy. The viable idea, business prototype, executive team quality, strategic partnerships, and early sales are among these variables.
The startup’s valuation is then calculated by multiplying each component by an arbitrary figure. As a result, the estimated startup value is between $2 and 2.5 million dollars. This strategy, however, is limited to pre-revenue firms. In addition, this method uses assumptions and is an exaggerated valuation technique.
2. Scorecard method
The scorecard technique employs the valuation provided to a company that has already received angel funding. It starts with locating a comparable company in the exact location and industry. After obtaining the company’s average pre-money value, the startup is rigorously examined to determine its strengths and faults.
Various aspects, such as the magnitude of the potential, new tech, managerial strength, competitive climate, advertising, financial requirements, and so on, are given importance.
3. Calculating risk factors
The risk factor summation method combines two earlier methods: the Berkus method and the Scorecard method. However, it also considers all business risks that may impact the startup’s level of profitability. Managerial risks, manufacturing hazards, market competitiveness, stage of organization, capital demand, political uncertainty, dispute, technology risk, and so on are some of the most typical issues to consider.
First, an approximate value is assigned to the enterprise using the valuation mentioned above methodologies. After that, several business risks are assessed as excellent or bad, and an estimation is added to or subtracted from the initial financial account. Finally, the startup’s ultimate value is calculated once the risk factor summing is applied.
4. Discounted Cash Flow
The DCF approach is one of the most extensively used techniques for evaluating a startup in the pre-revenue phase. The majority of the value of most pre-revenue firms is determined by their ability to generate money. Using the DCF method, an investor evaluates a startup based on the expected cash flows it will create in the future. The investor then determines the profitability value using an estimated rate of return on investment.
This valuation is then reduced for the period and risks involved at the investor’s desired rate of return. To put it another way, the DCF calculates the worth of a startup by integrating duration, hazard, and capital. You can also use DCF Calculator to find your company’s value. There are quite a few startup valuation calculators available to value your early-stage startup.
5. Method of Venture Capital
The venture capital approach, borrowed by the venture capital market, is yet another method of appraising a startup. This procedure aims to determine the startup’s value based on its departure or maturity value. The VC approach takes the volatility and other critical indicators from the P&L and multiplies them.
Next, the investor determines an exit value based on future profits. The departure value is often high because it does not consider the hazards. Finally, a depreciation (reflective of the startup risks) is added to the previously determined exit value to determine the return on investment.
6. Cost-to-Duplicate
As the name implies, the Cost-to-Duplicate technique includes determining the cost of starting a new business that is identical to the one being appraised. It accounts for all costs associated with generating the brand, including technologies, physical assets, investigation, and innovation, at their fair market worth. This strategy is based on the assumption that an investor would not like to pay as much as it costs to reproduce anything.
However, a fundamental flaw in this strategy is that it ignores the startup’s ability to generate future earnings and returns on investment. Another disadvantage is that it ignores intangible assets like brand image, creativity, etc.
7. First Chicago method
The First Chicago approach was created by and named for the First Chicago Bank’s venture capital arm. It is a method of valuing businesses used by debt and equity firms. First, Chicago helps analyze how feasible and aspirational the business strategy is by combining components of multiple validations and cash flow-based approaches. This strategy considers the best case, the average case, and the worst situation.
It is reasonable to conclude that determining the value of an early-stage startup is challenging. However, regardless of the problems, specifications, and variety of impacting factors, getting the best estimate possible is critical.
Calculating a high value might raise investor expectations, while predicting a low value may lead to the owners giving their investors a more significant equity stake. As a result, both company founders and potential investors need to determine a valuation that is as precise as feasible.
Shareholders can arrive at a fair value by using the correct strategy that considers the business idea, the economy it belongs to, the risk considerations, and the company’s potential. The appropriate method benefits both the investor and the founder when it comes to startup valuation.
It provides a greater understanding of the firm’s profits, resale, and genuine value. It also aids in acquisitions and obtaining capital to accomplish the firm’s future business objectives and ambitions. With all this, Eqvista has framed a system that is easy to use and efficient in means of operation; also our expert would stay intact to solve all your queries. Reach out to us.
