Business valuations in start-ups

Where to begin and who to listen to 

We’ve talked a lot about the importance of valuing your business. By knowing your value today, you can decide tomorrow’s value. But, most valuation models are based on historical revenue figures and hard facts – something that is quite hard to come by in a startup. With mature companies, a common valuation is done by looking at earnings before interest, taxes, depreciation and amortization (EBITDA). But startup businesses are usually in a pretty unstable stage when it comes to revenue. So how do you go about valuing a startup?

Quick recap of the basics

There a few different factors to take into consideration when valuing a startup. A couple factors that will raise the valuation are balance in supply and demand, well-functioning distribution channels and a positive reputation of the founder. On the other hand, a few factors that could lower a valuation are low margins, high competition and a management team without experience. Pre-revenue valuation models are of significant importance when it comes to startups, since most startups don’t have revenue in the beginning – let alone profit. More times than not, valuation comes into the picture when business owners are looking to bring in capital through an investment. What’s worth keeping in mind is that business owners will generally want to value their company is high as possible, while investors are looking for the lowest valuation possible in order to maximize their return on investment (ROI).

Look at the company you keep

The most common valuation framework is actually combining several different models and finding a sensible average. Since startups usually don’t have historical numbers to go on, the models are based on well-founded predictions. The first useful model is the Comparable Transactions Method. Find out how much similar companies in your industry and region are worth.

Peek into the future

A second common valuation model for startups is the Berkus method. Designed by angel investor Dave Berkus, you start by asking yourself if you believe that your company can reach $20M in revenue by the fifth year of business. If your answer is yes, then you start looking into the following factors; sound idea, prototype, quality management, strategic relationships and product rollout. The model clearly shows how valuations of startups are built on the prognosis of future development.

Keep track of your scoreboard

A more elaborate approach to startup valuation is the Scorecard Valuation Model. Determine an initial value for your company and then adjust in accordance to 12 risk factors. These factors include, among others; stage of the business, manufacturing risk, technology risk and potential lucrative exit. These factors are modified and weighed up depending on their impact on the overall success of your company.

A valuation is always a good starting point when looking to bring in capital. It helps you to look objectively at the company and enables you to base your argument on numbers. To sum it up; a valuation is never permanent. You can always influence your valuation, especially as a startup!