How startup valuation works
Putting a value on your fledgeling business isn’t easy, as so much of what makes a startup valuable is bound up in its future potential, rather than any profits or assets you hold now. Nonetheless, if you’re seeking investment, want to set a fair share price, or even sell your company, the value of your startup is something you’re going to need at least a vague idea of.
So, what is startup valuation, and how does it work?
Methods of valuing a startup
There are a few commonly used methods and equations for valuing a business. However, you’ll find that most of them are based around the kind of figures and metrics that your startup may not yet have acquired. For example:
- The Multiplier – The Multiplier is enticing because it seems to promise a single figure based on a simple equation: net profit of business x market share = business value. However, the factors involved are pretty variable, especially for startups, who frequently don’t see any profits for the first couple of years, at least.
- Asset and entry valuation – These work by calculating the value of your assets and/or the cost of setting up your business at entry-level under current market conditions. Both are handy in that they take things like team members and intellectual property into account, but they’re not so good at calculating things like future potential (which is the major asset upon which many startups trade).
- Discounted Cashflow – The discounted cashflow method of valuation only really works if you’re a well-established multinational, so I’ll spare you the complex details here. Essentially, it predicts future potential by studying past trends within the business. It’s good in that it acknowledges the importance of potential, but it’s not so useful if you’ve not been around long enough to build up a hefty bank of past cashflow statistics.
As you have probably gathered, none of these makes it much easier for those of us wondering how to value a startup. Valuing a startup is a process of speculation, of establishing the worth of future potential – and that can be quite a subjective thing. Instead, the best way to get a handle on how your valuation might go is to take a look at the factors which can affect the value of a business.
Factors affecting the value of a startup:
- Brand reputation. If your startup is well branded and has some buzz about it, chances are it’ll be considered more valuable than less well-known and/or well-trusted competitors.
- Customer base. A loyal, concentrated customer base that has a good relationship with your brand speaks volumes about your future potential. You don’t need a large customer base at this stage – it’s all about how well those customers you do have, stick.
- Your bargaining position. Why are you doing this valuation in the first place? Is it because you’re ready to grow (in which case you have greater potential, and therefore greater value)? Or is it because you’re being forced to sell (which doesn’t bode well for your business model)?
- How future-proof you are. OK, nobody can see into the future, so this one is hard to calculate. But most people will have some idea of how sustainable an idea is in the long term. If you’re an enthusiastic start-up with solid foundations and a viable, adaptable product then you’re likely to be more future-proof than a flash-in-the-pan enterprise based on what happens to be trendy this month. Think about how you can move and change with the times in order to up this element of your value.
- Do your research. While you shouldn’t get too caught up in what similar businesses are doing, researching the value of similar startups can definitely help to work out where your business sits. Also, ask around within your network of investors and entrepreneurs to get an objective perspective on your worth.
- The bottom line. Monetary values aren’t the be-all and end-all when it comes to startup valuation (how could they be?). But they are still important. The better your profit margins and ROI are looking, the higher your value will be.
Valuing a startup is by no means an exact science. The value an investor may mentally ascribe to your startup depends a lot on how you pitch yourself to them, and remember, they will always be looking to negotiate. However, before you start writing a glowing tale of potential profit, a word of caution: realism and a grounded understanding of your market will take you much further than blind ambition.
One of the most valuable assets your startup has is its people – and if those people are demonstrably ignoring potential issues with their business model, that does not bode well. On the other hand, a sense of realism and a willingness to work on gaps in the plan show that your startup is rising from strong foundations - and that smacks of much more potential than a great initial profit surge.
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