“One of the things that I’ve been quite keen on internally and externally is that the valuation of our company has not been a focus for us. It’s not a goal we’re aspiring to achieve.” – Ham Serunjogi, CEO of ChipperCash.
We agree with Ham, but we also think that valuation is one of the KPI that matters in any startup.
Practically speaking, the valuation of your startup at each round has important implications for you and for the future of your company. However, some startup owners still get it wrong which makes them liable to losses. Today’s treat focuses on how startup Valuation is calculated.
Before we proceed, let’ s understand first what Startup Valuation truly is.
If you already know, thumbs up to you. If you don’t, thumbs up to you too, you are about to discover something new, Learning never ends, remember that.
To free you and us from ambigousness, startup valuation in simple terms is the process of quantifying the worth of a company, aka its valuation.
Calculating a startup’s valuation is the method of doing a business valuation, commonly referred to as a startup’s valuation. The value of a business and each of its departments or units are assessed during the valuation process.
A startup valuation can be established for a number of purposes, such as sale price, determining partner ownership, taxation, and even divorce processes.
To avoid a biased assessment of their startup’s value, founders oftentimes result in hiring professional hands to access their business.
Business finance discussions regularly touch on the subject of startup valuation. A startup often does a business appraisal when it wants to sell all or part of its activities, combine with another business, or buy another business.
The process of estimating a company’s present value while considering all of its facets involves doing a startup valuation.
A review of a startup’s management, financial structure, the potential for future profits, or the market worth of its assets may be included in a business valuation.
Depending on the evaluator, the company, and the industry, many tools may be employed for appraisal.
Examining financial records, discounting cash flow models, and similar brand comparisons are popular methods for valuing businesses.
Some of the methods of determining startup valuation;
The Berkus Method, developed by American angel investor and venture capitalist Dave Berkus, focuses on evaluating a start-up business based on a thorough analysis of five crucial success factors: (1) Fundamental value, (2) Technology, (3) Execution, (4) Strategic Partnerships in its Core Market, (5) Production and Resultant Sales.
The quantitative value that the five critical success elements provide to the enterprise’s overall worth is assessed in depth.
These figures are used to value the startup. The Stage Development Method or the Development Stage Valuation Approach are alternate names for the Berkus Approach.
The Cost-to-Duplicate Method
Considering all costs and expenses related to the startup and the creation of its goods, as well as the acquisition of its physical resources, is part of the Cost-to-Duplicate Method.
The startup’s actual market value depending on all expenses is calculated by factoring in all such costs.
The cost-to-duplicate strategy has the following shortcomings: not taking into account the startup’s possibilities for the future by making projections about its future sales and expansion. not accounting for its intangible assets in addition to its real assets.
The claim is that even at the beginning stage, the startup’s intangibles, such as brand value, prestige, intellectual rights (if any), and so on, may have a significant value for its valuation.
Multiple Future Valuation Methods
The Future Valuation Multiple Approach is primarily concerned with determining the expected return on investment for investors in the next five to 10 years.
The company is valued depending on a number of estimates that are made for the aforementioned reason, including sales projections over a five-year period, growth prospects, cost and expenditure projections, etc.
Market Diverse Strategy
One of the most often used techniques for valuing startups is the Market Multiple Approach. The market multiple approaches function similarly to other multiples.
The company in issue is compared to recent market purchases of like kind, and a base multiple is established based on the worth of those new purchases. The base market multiple is then used to determine the startup’s value.
Approach to Summarizing Risk Factors
The Risk Factor Summation Approach assesses a company by quantitatively accounting for all business risks that may have an impact on return on investment.
The risk factor summation method involves estimating the startup’s starting value utilizing any of the other techniques covered in this article.
The impact of various business risks, whether favorable or unfavorable, is considered in relation to this baseline value, and an estimate is applied to or subtracted from it depending on the impact of the risk.
The total worth of the startup is calculated after accounting for all possible risks and adding the “risk factor summation” to the startup’s original assessed value.
Management risk, political risk, manufacturing risk, market competitiveness risk, investment and capital accumulation risk, technology risk, and legal environment risk are a few examples of business risks that are considered.
Discounted Cash Flows
Predicting the startup’s future cash flow movements is the main goal of the discounted cash flow (DCF) method.
The value of the anticipated cash flow is then calculated using an assumed rate of return on investment known as the “discount rate.”
A large discount rate is typically used since startups are still in their early stages and investing in them carries a significant level of risk.
So besides funding rounds, should you care about valuation or not? You probably already do.
Every time you make a decision, you are trying to guess which scenario is going to have a better impact on your valuation. Every scenario has a component of both risk and return, and valuation is the only KPI that puts them together.