Valuation Trends and 8 Important Methods to Value Startups
VC-backed enterprises raised $329.9 billion in 2021, which is almost a 100% rise above 2020’s record of $166.6 billion. Early-stage VC activity topped $80 billion, while annual exit values rose to $774 billion. This massive flood of capital drastically increased startup valuations in 2021. Entrepreneurs and investors are wondering what the future holds once the Covid-19 pandemic ends. Can sky-high prices last? Should we expect a crash from the current investing frenzy? What’s the future of valuation? And how do valuation methods take place?
The key to successful investing lies in the ability to forecast a startup’s future cash flows while understanding the factors that have an impact on those cash flows. Thus, the valuation of a startup requires the ability to drive investors towards more informed decisions.
What’s the value of your startup?
Startup Valuation is the process of determining the values of companies that are currently in their early stages. These are companies that are either seeking funds or have been founded but are not yet established in their markets. The valuation of such startups can be extremely complex, particularly those with no previous track record of revenue or profits.
As per Pitchbook-NVCA Venture Monitor, venture capital investments in the US doubled between 2020 and 2021. Furthermore, the number of deals increased from 12,173 to 15,500, or about 27%. This signifies that the trend is towards higher valuations for the smaller number of startups.
What’s in store for startup valuations in the future?
Currently, the levels of investment are unsustainable as the supply of money is no longer increasing, due to which there will be a slowdown in venture capital deals. However, the amount of funds already committed and available remains high. In terms of valuations, it is inflation in the startup prices instead of a bubble.
The future of startup valuation is likely to show a halt in valuation growth at the early stages. For later-stage startups, the valuation fluctuates in regard to changes in the stock market. The “flight to quality” is visible where attractive startups continue to be in high demand along with enjoying the higher valuations, while weak startups may struggle to raise the next investment, potentially leading to flat rounds or downside moves.
The startup’s risk diminishes, and its valuation improves as it attracts more clients and develops a repeatable sales model. In the next table, you’ll see the startup failure rate at various points of its lifecycle.
There are three stages of startup development: seed, early, and late (Series C and beyond). Different ways of valuing startups are used depending on factors such as the company’s stage of development and the type of product or service it provides. Pitchbook reported that Seed-stage startups will be valued at $9 million on average in the US in 2021, while Series-A startups will be valued at $ 35 million on average.
Valuation Methods for Startups
Below are the 8 Valuation Methods for Startups or frameworks from the financial industry. Due to the fact that valuations are based on data that is not readily available for many startups, you must take care in determining whether your model is reliable in creating a sound valuation.
1. Discounted Cash Flow (DCF)
The idea behind this method is to estimate future cash flow value. It is usually carried out by estimating the company’s EBITDA, cash flows, and terminal value. In addition, the future cash flow value is discounted to the present value using the weighted average cost of capital (WACC) and a discount rate. This is the most widely used valuation method in the industry, and it is often used to determine the value of early-stage startups.
A DCF calculator is available at Eqvista, and it can be used to interpret the value of a startup by providing the basic details of the startup.
2. Scorecard Valuation Method
The scorecard value model is a simple method that consists of a set of financial and non-financial criteria. Each criterion is assigned a weighting that can be made based on real information about a given startup. These factors include the strength of the team, the target market, the size of the market, product development, investment and funding, and some minor factors. All of these different criteria are then rated in percentage based on the information provided. Once this step is done, all of the different criteria are then added together to create one summary score. This score is then compared to the target market-based required value.
In the Scorecard Valuation Method, if the startup’s score is higher than the market requirements, then it can be considered an attractive opportunity for investment. However, if the score is lower than the market requirement, then it should be considered for investigation and further research.
3. Cost-to-Duplicate Approach
This method aims to determine the value of a startup by calculating all costs and expenses associated with the current startup, including development costs, marketing costs, sales and distribution costs and any other costs associated with the startup. Once the total cost of the startup is determined, this determines the startup’s fair market value based on all the expenses. In simple words, the Cost-to-Duplicate Approach measures the amount required to replicate the same startup for which valuation is being conducted.
4. Risk Factor Summation Method
The Risk Factor Summation Method helps determine the value of a startup based on the risks associated with the startup. The key risk factors that need to be considered include competitive threats, legal disputes, technology risks, financial risks, management risks, funding risks, and market risks. Each of these risks is weighed based on its severity and the degree of impact on the value of the startup. The sum of these factors is then used to determine the perceived risk of the startup. The result of this calculation is then compared to the target market-based risk required value. It is important to note that the volatility of the results can be vulnerable and depend on the inputs that are made.
5. Venture Capital Method
Professionals and analysts tend to use the Venture Capital Method to determine the value of startups. The VCM method estimates the exit or terminal value of the startup once it has reached maturity. The exit value refers to the price at which the company can be purchased or sold. However, determining this value can be particularly complex for startups because of the high degree of uncertainty regarding their growth potential and their business plans. The analyses of exit values should be carefully performed by professionals and experts as their figures are used to help determine the value of the company.
6. Book Value Method
This method attempts to determine the value of startups based on their book values. This can be determined by subtracting the total liabilities from the total assets of the startup. The result of this calculation is then considered to be the fair market value of the startup. However, it is important to take into consideration that this method cannot properly account for intangible assets such as intellectual property, reputation, etc. In addition,
Book Value Method is also known as Asset-Based Approach which involves the ability to analyze a company’s assets, liabilities and owner equity in order to determine its fair market value.
7. The Berkus Method
Founded by Dave Berkus, this method utilizes the five key factors that include the sound idea, product prototype, quality of the management team, strategic relationships, and initial sales. According to Berkus, these factors can be used systematically to come up with the fair market value of the startup. A detailed assessment of each of the factors can be used to create a model that will help determine the value of the startup. However, the Berkus Method can be extremely complicated and difficult to implement due to the high degree of uncertainty involved in its performance.
8. Comparable Transactions Method
This method is generally used for mergers and acquisitions (M&A) in order to estimate the value of a startup. The comparable transactions method identifies similar or comparable past transactions where the target business of the acquisition has a similar business model and is similar in size. The calculation is done by comparing all of the relevant attributes of the relative transaction. The result of this comparison is then used to determine the value of the startup based on its fair market value.
We believe that current startup valuations will continue to rise, at least for the time being. While some valuations may fall, it’s vital to keep in mind that the money has already been spent and distributed. You won’t have a sudden crash to worry about because it cannot be “taken back”.
There are a number of different valuation models that can be used to determine the value of a startup. Understanding the different approaches and their methods can help an investor or professional draw an accurate conclusion about a startup’s fair market value.
Eqvista is here to assist in this process by offering users the ability to perform valuation analyses for startups. The team of professionals and experts at Eqvista has extensive experience in valuing startups across the globe. Eqvista will choose a valuation model that best suits your project and will help you determine its value.
