Introduction

In the dynamic world of startups, understanding the value of a business is crucial. Startup valuation, the process of determining the worth of a startup, is a complex yet essential aspect of the entrepreneurial journey. It involves several factors, including revenue, market size, and growth potential, among others. In this article, we will explore various aspects of startup valuation. Throughout this discussion, we will delve into topics such as how to value a startup, popular startup valuation methods, calculating the valuation of a startup, the significance of 409A valuation for startups, industry-specific startup valuation multiples, and the usefulness of a startup valuation calculator. By the end, you will have a comprehensive understanding of startup valuation.

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Current State of Startup Valuations

As we navigate through 2023, the startup ecosystem is witnessing a slow yet steady recovery in valuations. The economic uncertainties of the past years have given way to a more optimistic outlook, with valuations gradually trending upwards. This recovery is not just a testament to the resilience of startups but also an indication of the evolving strategies and tools employed for valuation.

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How to valuate a startup

Particularly for early-stage startups or pre-revenue businesses, startup valuation can be a challenging endeavor. Founders frequently struggle with the issue of how to valuate a startup since it is a difficult process that combines art and science.

Consideration of “value” outside of monetary terms is one method to approach the concept. A startup’s personnel, pipeline, and technology. For instance, they can all add to its overall value even if it is not currently making money. Due to its more arbitrary nature, appraisal is known as “art” in this case.

However, there are even more scientific ways to estimate startup valuations. A more methodical approach to valuing can be achieved by investigating prices paid for similar businesses and creating revenue or EBITDA multiple. Because it is based on data and is simpler to quantify, this is known as the “science” of value.

It is crucial to take into account both the art and science of valuation when evaluating startup valuation. For instance, even if a startup is producing more revenue or profits, it may be valued more than a similar business that lacks a great team, a promising pipeline, and creative technologies.

In addition, it’s crucial to take into account the startup’s sector, market, and condition. Startups in industries with high valuations for comparable businesses may be valued more than those in sectors with lower valuations.

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How to calculate the valuation of a startup?

Financial analysis, market research, and growth forecasts are all factors that go into determining a startup’s value. The Startup Valuation Methods listed below are frequently used to determine a valuation, even though they are not scientific and can be arbitrary.

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8 startup valuation methods

There will always be an element of guesswork involved in calculating startup valuation, but there are some beneficial resources you can have on hand. Balance sheets and other financial statements are essential. Prepare yourself to evaluate the skills and experience of your team and identify its strengths and weaknesses.

Here are eight prevalent startup valuation methods to calculate startup valuation potential earnings:

The Berkus Method

The venture capitalist Dave Berkus developed the Berkus Method to determine valuations exclusively for pre-revenue startups or companies that have not yet started selling their goods on a large scale. The goal is to give monetary value to five crucial success indicators seen in early-stage enterprises. 

The five crucial success characteristics are evaluated in great depth to determine their monetary value. The total of these monetary values is the startup valuation. The standard allocation for this strategy is up to $500,000 per success factor, with a notional pre-money valuation cap of $2.5 million. The stage development method or the development stage valuation methodology are other names for the Berkus approach.

Comparable transaction method.

One of the most popular startup valuation techniques is the Comparable Transactions Method because it relies on precedent. You’re answering the question, “How much did startups like mine get acquired for?”

For instance, imagine that a fictional shipping startup called Rapid was acquired for $24 million. The mobile app and website had 700,000 users. Each user pays approximately $34. 120,000 users are using your shipping startup. Your business has a valuation of about $4 million.

Similar companies in your sector also provide revenue multiples. It can be typical for SaaS businesses in your industry to produce 5x to 7x the net revenue from the prior year. 

When using a comparison model, you must consider ratios or multipliers for any significant differences between your two businesses. For example, if another SaaS company possesses proprietary technology and you do not, you may consider using the multiplier on the lower end of the range, such as 5x (or lower) in our example above. The Market Multiples Approach is similar to this method.

Scorecard valuation method

The Scorecard Method is an additional choice for pre-revenue enterprises. It also works by comparing your startup to others that have obtained money but have more demands placed on them. 

First, you determine the average pre-money worth of comparable companies. Then, you’ll think about how your company compares to the following characteristics. 

Team strength: 0% to 30% 

Opportunity size: 0 to 25%

Product or service: 0–15%

Competitiveness: 0% to 10%

Partnerships, marketing, and sales channels: 0–10%

Investment increase required: 0-5%

Other: 0-5%

Then you will assign a comparison percentage to each quality. Essentially, for each attribute relative to your rivals, you might be on par (100%), below average (100%), or above average (>100%). For instance, you award your e-commerce team a 150% score because it consists entirely of skilled developers and marketers, some of whom have worked for competitors. To reach a factor of.45, you would need to multiply 30% by 150%.

Find the total of all the components by doing this for each startup quality. Then, multiply that sum by the normal valuation in your industry to arrive at your pre-revenue valuation. Bill Payne, the method’s developer, explains how to weigh each element and give percentages in detail. 

Cost-to-duplicate approach.

The name of this technique contains the secret. Taking into account any intangible assets, such as your brand or goodwill, you are estimating the cost of replicating your startup elsewhere.

To determine your physical assets’ fair market value, simply add them up. You can also include costs for product prototypes, patents, and research and development.

One significant problem is that this approach automatically undervalues a company, especially if it is making money. You might have to discount factors that are extremely important, like your startup’s customer involvement, when determining its valuation. 

Risk factor summation method.

This Risk factor summation method of startup valuation is more thorough. Start by performing an initial value using one of the various techniques described above. Then, based on hazards impacting your company, increase or lower the monetary value by multiples of $250,000.

Low-risk components receive a double-plus grade (++), which raises your valuation by $500,000. The grade for high-risk components is a double-minus (–), and you deduct $500,000.

For instance, you can rate your online bespoke apparel company favorably but only add $250,000 if there is a minor but minimal chance of competition.

The following are the 12 typical risk categories: 

Management

stage of the enterprise

Political and legal risk

risk in manufacturing

Risk in sales and marketing

Funding/Raising Capital Risk

Risk of competition

Technology hazard

Risk of litigation

Risk on a global scale

Risk to reputation

Potentially prosperous exit

The most challenging part of this strategy is determining an impartial point of comparison to evaluate each component. It could be helpful to start with comparable approaches, such as the Scorecard Method or the comparable Transactions Approach. 

Discounted cash flow method

The discounted cash flow (DCF) method is another way to value businesses. To employ this technique, you might need to collaborate closely with a market analyst or an investor.

After applying a discount rate, also known as the anticipated rate of return on investment (ROI), you calculate your projected future cash flows. Generally speaking, the riskier the investment and the better your growth rate needs to be, the higher the discount rate.

The reasoning for this is that investing in startups has a higher risk than investing in companies that are already up and running and generating steady profits.

The First Chicago approach, which builds on the DCF approach, is another option to think about. It takes into account three alternative situations, two of which are that the start-up does worse than anticipated and one in which it performs even better than anticipated, giving you three different business valuations.

Venture capital method

As the name implies, this approach is used by venture capital firms, and it is one more choice to take into account if you require a pre-revenue valuation. Additionally, it reflects the perspective of investors who plan to leave a company after several years. 

You’ll work toward your valuation using two formulas:

Expected Return on Investment (ROI) = Terminal Value – Post-Money Valuation

Post-money valuation = end value expected return on investment

The estimated selling price of your startup once the VC firm has invested in its terminal value, which you will first determine. You can determine this using the price-to-earnings ratio or the projected revenue multiples for your sector.

To find your post-money valuation, determine the expected ROI, such as 10x, and then plug everything in. Get your pre-money valuation by deducting the requested investment amount from that point. 

Book value method.

The book value method provides an asset-based valuation. The cost-to-duplicate approach is similar, but this approach is even simpler. 

Traditionally, a startup company calculates its book value by subtracting its liabilities from its total assets. In other words, your valuation is equated with the net worth of your startup using the Book Value method.

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409A valuation startup

A 409A valuation startup is a necessary prerequisite before extending equity offerings, such as stock options, within your organization. Startups must conduct an annual update of their 409A valuation. Additionally, it is recommended to obtain a new valuation whenever there are significant changes that have an impact on the business’s value.

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Startup valuation multiples by industry

While traditional businesses are frequently valued at a multiple of their EBITDA (earnings before interest, taxes, depreciation, and amortization), startups are typically valued at a multiple of their revenue because they typically experience significant losses. The industry, business model, growth, and other arbitrary factors like the management team’s level of experience or the likelihood of disruption all affect the multiple.

As a result, if B2B software businesses sell at 20x multiple, private valuations for that sector may also be trading at that level. The performance of publicly traded companies in the same sector also has an impact on startup multiples.

Multiples of startup valuation:

SaaS: typically 10x revenues; but, depending on the stage, growth, and gross margin, it may be higher.

E-commerce: 2-3 times sales or 10–20 times EBITDA.

Hardware, low-margin businesses, and marketplaces: 1-2x revenue.

Travel: low-margin verticals like flights generate 1-2x revenue, whereas hotel reservations generate 6–8x.

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Startup valuation calculator

There are various online startup valuation calculators available to help you determine the value of your firm but before beginning any of these processes, it’s crucial to consider why you need the valuation and whether you need to share it with outside parties. Additionally, where your corporate headquarters are will matter:

Europe

Many firms, such as Equidam and Valorem, provide business appraisals starting at 300€, however, these are of limited value for raising money or selling the business because other aspects, such as bargaining strength or investor interest, would be more important.

The United States

Experts advise adhering to the 409a standard, which some specialized companies offer for $500; however, the cost varies depending on the size of the business.

Other areas

Online valuation services are available from Equidam and other comparable businesses.

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Future of Startup Valuation

As we progress through 2023, we can expect to see more refined startup Valuation Methods for evaluating startup success. The focus is shifting from merely scaling to nailing the business model and demonstrating sustainable growth. This evolution in valuation methods reflects the maturing startup ecosystem and the increasing emphasis on long-term success over short-term gains.

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Conclusion

Business valuation is essential for success in the dynamic startup environment of 2023. Startup valuations are steadily rising as a result of resiliency and changing business models. Startup Valuation Methods like the DCF Method, Comparable Transactions, and Berkus Method offer insights while the art and science of valuation are at play. A change toward sustainable growth and long-term prosperity occurs as the ecosystem ages. The success of startups depends on accurate valuation, which helps founders and investors make wise decisions.

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