How to value a startup?
For some reasons you would like to know how much your startup is worth, maybe you are searching for investors and you want to know what offers you should expect, or maybe you are searching for a co-founder and want to give him some equity or you are planning on selling you startup. Basically if you are asking yourself: “how do I value my startup?”, then you are in the right place, let’s start.
There isn’t a single method
You should have seen it coming, of course, there isn’t a single method with which startups are valued, this is because of the intrinsic uncertain nature of startups. Startups are businesses that don’t have a lot of historical data and that are highly volatile, this means that they could go to zero or one-hundred in just a couple of months.
This is why valuing a startup is much harder than valuing a normal business. Either way, let's explore the various common methods.
Market Multiple Approach
This approach is probably the most popular for evaluating a startup. The method is very simple, you need to look at what other similar companies are sold for and you get the value of your startup. For instance, if companies in your sector are selling for around ten-times sales, you can get the estimate for your startup in that way.
The problem resides in finding companies similar to yours, every company is different and there probably isn’t recent data about an acquisition of a company in you field. In addition to this, it is hard to value very early startups or pre-revenue startups, since you don’t have a value to multiply.
The pros of this method is that it gets its data from past acquisitions, so you know that someone is willing to pay that amount for a similar startup.
This method focuses around the question of: “how much money would I need to duplicate your startup?”. Basically if I started from scratch today, how much money would I need to invest in a similar company? This method revolves around the idea that investors wouldn’t pay more than what you would need to build another one from scratch.
To calculate all the assets of, for example, a software company you would sum all the proprietary software, the eventual patents and the cost of the developers that would need to work on the project, plus any other cost (such as UI and UX design).
Unfortunately this method doesn’t take into consideration all the “intangible assets” such as brand, potential for growth and competitiveness of the industry.
As I think you would agree, finding customers and getting known, is actually the hardest part of starting a business and this method completely ignores that part.
This method gets it’s name by it’s inventor Dave Berkus, an angel investor, and revolves around five different metrics:
- Valuable business model (base value)
- Available prototype (reducing technology risks)
- Abilities of the founding or management team (reducing implementation risks)
- Strategic relationships (reducing market risks)
- Existing costumers or sales (reducing production risks)
As you can imagine this method is very dependant on the person using it and relies heavily on the experience of the person doing the valuation.
Discounted cash flow
And finally we have (to my opinion) the best method, the discounted cash flow, DCF for short. I like this method the most, because it is the only one that is based on actual numbers that can be checked and updated over time to provide a fair and comprehensive valuation for your startup.
The DCF method involves forecasting the cash flow that the startup will produce in the future and then “discounting” that cash flow to calculate how much it is worth. An higher discount rate is typically used for startups since they are an high risk investment.
The only problem with the DCF method is that it heavily depends on the forecast and on the assumptions that are made when creating the financial model, leaving the method very dependant on the analyst who makes the forecast (if only there was a better method… SPOILER, there is).
As you may have guessed it is extremely hard to value a company, especially a startup since they operate in unknown territory, but hopefully now you have a clearer understanding of the possible methods and maybe want to valuate your own startup, if yes, then stick to the end to find out if there is a better way to valuate your startup.
A new method
As I’ve hinted in the discounted cash flow method, the main problem with it, is that creating the financial forecast is the hardest part and is highly subject to errors if an assumptions (for instance churn rate) is wrong. This is the problem that we want to solve with Sturppy.
With our platform you can create a financial model for your startup in 5 easy steps that don’t require more than 15 minutes, meanwhile our AI will check if your assumptions are too optimistic or too pessimistic based on thousand of free startups data.
At the end you have a solid financial model that has accurate assumptions, do you see where we are going now? Now that you have a realistic financial model we automatically calculate your startup value with the discounted cash flow method based on the cash flow that you startup will generate. All in a single platform.
This is just a demo (xEBITDA = 10, 2 years projection). We made many assumptions and over-simplified a lot.
If you want a precise valuation just join Sturppy and get a valuation for free in less than 20 minutes.
Sturppy is so much more and can also help you get investors since you can just share with them the link to your financial model, if you want to learn more, check out our features.
Thank you for having read this far, if you enjoyed the article, please share it with someone that might need it.
If you would like to create the financial model for your startup and get an accurate valuation, you can create a free account now on Sturppy.
Good luck on your journey.