How to Value Your Startup: 3 Common Approaches
- December 18, 2017
- Posted by: Admin
- Category: Valuation
Let us assume that you have found a willing investor who is impressed with your business model, and wants to invest in your startup. Once the preliminary discussions are done, your investors would inevitably want to know the valuation of your business. So, the big question is: How to Value Your Startup?
Valuing your startup is often a tricky game, with a lot of assumptions. But this is a game that you need to play, considering the fact that investment capital is stubbornly scarce. Quoting a low valuation, would often imply that you need to give away a substantial stake in your business. Shooting it high, could make you lose the deal.
So, if you are faced with multi-million-dollar question: “How to Value Your Startup”, here are three techniques that can help. Your best bet would be to use a combination of these three techniques, depending on your business:
Technique No. 1: The Market Approach
Under the market approach, you would be using market data to justify the value of the startup. In the recent years, this has become a common method of evaluating pre-revenue and early stage startups.
Under the market approach, you look at companies that have recently raised capital, and benchmark your metrics (like revenue, profit, number of users etc.) against these companies to arrive at the valuation. This method is very similar to how we tend to look to value your house, by comparing it to similar homes recently sold in your area.
One of the drawbacks of using this approach is finding an exactly similar business, in your niche, that has recently raised capital, and finding out its metrics (which are not usually available in the public domain).
Technique 2: The Income Approach
Perhaps the second most commonly used technique is the income approach. Under the income approach, the performance of your startup is projected into the future. This involves drawing up cash flow projections, backed by assumptions. These cash flows are then discounted to their present value, using discount rates, to arrive at their value.
The younger your startup, the greater the uncertainty of its future earning power, and the larger the discount rate. In pre-revenue startups, where you do not have sufficient earnings, and traction, this technique may prove to be less useful.
Technique 3: The Asset Approach
The analogy of the asset approach is that the business is valued as the sum of its parts. By placing values on the assets on the balance sheet, you could easily arrive at the value of your startup. You can start with physical assets such as equipment, machinery, furniture, and then move on to intellectual property. As many startups have little investments in physical assets, valuing your intellectual property becomes important. This could include patents, copyrights, and trademarks.
Whether you are looking to raise capital, or planning to grow your startup, the question of: “How to Value Your Startup” often becomes critical. By using a combination of these three approaches you are likely to arrive at an indicative value. Remember, valuation is both an art and a science. Using the right techniques and the right assumptions make or break the game of valuation.