What does Company Valuation for Startups Mean?
Startup valuation is the
art of estimating a company's worth—an important
task for entrepreneurs. During the seed funding round, investors invest
funds into a startup and acquire a share of its stock. This exchange
determines the ownership stake entrepreneurs must offer in return for
financing. Simultaneously, investors need clarity on the amount of company
stock they'll receive in exchange for their contribution.
Furthermore, before assessing the actual value of a firm, founders must
have a thorough understanding of the startup valuation process. Even if
there is no revenue generating, seed investors will have
high expectations and if a firm is unable to fulfil the lofty targets, it
may have to raise funds at a reduced valuation in the following round.
This could be detrimental in the long run, as the startup or founder may
have difficulty convincing other seed investors or companies to provide
venture capital. If the firm quotes too low, it may end up handing a
larger portion of its stock to investors, which will be detrimental to the
startup.
What is the Significance of Company Valuation for Startups?
With the rising trend of startups and entrepreneurship, there is a growing
demand to achieve a high valuation, making startups a
possible location for investment or funding the expanding business at an
early stage. A professional external evaluator can assist
in identifying important performance metrics such as revenue capital or
profit estimation, as well as presenting future growth prospects. If a
startup has a greater valuation, it can give less stock or shares in
exchange for funding from an investor.
StartupFino specialises in providing company valuation services for
startups with presence across major cities of India.
How Company Valuation for Startups is Determined by Registered Valuers?
A startup is a newly created business with the potential for quick growth
that offers novel products, services or ideas. To support their business
strategies and drive growth, these firms require various sorts of finance.
There are various fundraising possibilities accessible in India, including
angel investors, venture capitalists, crowdfunding and
bootstrapping. Due to the inherent insecurity and lack of profitability during the
early stages, companies are frequently required to get guarantors when
seeking finance. This is because valuing a business becomes difficult
until it reaches its break-even point.
Valuing startups in India presents a greater challenge compared to
established enterprises boasting robust financial histories. While mature
corporations can rely on metrics like earnings after taxes, interest,
depreciation and amortisation for valuation, the process becomes intricate
for startups. In India, the business's worth is determined by registered
valuers, such as the
Insolvency and Bankruptcy Board of India (IBBI), who
consider a range of positive and negative factors.
Positive Factors Considered:
- Reputation or brand value of the startup
- Customer traction and growth potential
- Existence of a prototype for the business
- Revenue generated up to the valuation point
- Supply and demand dynamics, including distribution channels
- Market value and potential market size
Negative Factors Considered:
- Low profit margins affecting price determination
- Weak industrial value or lack of competitive advantage
- Intense competition in the market
- Assessment of the startup's product offerings
- Evaluation of the management team's capabilities and performance
Major Factors to be Considered for Startup Valuation
It is equally significant to consider the factors that determine a startup
company's valuation. These factors are as mentioned below:
Traction
This is one of the most important elements influencing seed stage
valuation. Traction, which is mostly
quantitative confirmation of client demand, indicates
that a startup is taking off. Simply said, traction demonstrates progress
and expansion, which is why it is the most critical factor in persuading
investors to invest in a firm.
Reputation
Before going with the valuation round, founders must ensure a
positive market image. The founder's image and capability
are two of the most important factors that an investor considers before
investing.
Prototype
The creation of a prototype is a significant factor that can influence an
investor's decision. So, before you pitch an investor, make sure the
prototype is complete.
Revenues Before Valuation
Revenues are unquestionably vital for any firm since they facilitate
appraisal by investors. So, if a product has already hit the market and is
generating income, it may sway
an investor's choice in favour of that firm and serve as
a deal sealer.
Channel of Distribution
It is extremely possible that the product/service will be in the early
phases of any startup as well. As a result, entrepreneurs must exercise
caution when selecting a distribution channel, as this
might have a direct impact on valuation.
The Business
If the startup is in a booming industry, investors will
almost certainly pay a premium. This means that it is critical to select
the appropriate industry because it will raise the value of a commercial
enterprise.
What are the Methods Used for Company Valuation of Startups?
Businesses and Professional Valuation consultants
like StartupFino employ a range of comprehensive and
accurate methods to determine the value of a startup. These valuation
methods take into account various factors that influence the overall
valuation of a startup company. The following are the key methods:
1. Self-Evaluation Method:
To accurately evaluate a startup, common emphasis is laid on the
importance of self-evaluation. This entails tracking and assessing all the
company's assets. Within the
Key Progress Indicators (KPIs), indicators such as
profit, market share and customer satisfaction hold paramount importance
as they provide insights into the firm's performance.
2. Cost-To-Duplicate Method:
On the other hand, the Cost-To-Duplicate Method takes into account all the
expenses involved in recreating the startup from the
ground up. This encompasses costs related to products, assets and
infrastructure. By assessing the genuine cost of establishing a comparable
startup, valuable insights into the overall value of the startup are
obtained by investors.
3. Market Multiple Method:
The Market Multiple Method involves
assessing the profitability of a product within the market compared to
similar companies. For example, if a startup plans to introduce a product to the market,
investors analyse the existing market value of comparable products to
estimate potential profit rates before making an investment. This method
is significant for a variety of reasons but foremost because it provides
investors with a very clear understanding of what could be the potential
profitability in future for the startup.
4. Discounted Cash Flow Method:
The DCF Method is a complicated approach that calculates the
present value of the startup's estimated future cash
flows. It entails forecasting profits, losses, asset prices and the
company's overall worth. Additionally, the method incorporates a
discounted rate of return to account for the risk of the startup's failure
to thrive. This method helps determine the intrinsic value of the startup.
Preparing the Valuation using the Discounted Cash Flow Method:
Step 1: Evaluating the Firm's Current Position:
- Determine the firm's current revenue for the year.
- Assess the company's cash burn rate.
- Analyse industry projections.
Step 2: Estimating Revenue Growth:
- Identify revenue growth through various approaches:
- Consider the firm's historical revenue growth rate.
-
Evaluate the growth rate of the overall market the firm operates in.
-
Assess barriers to entry and competitive advantages possessed by the
firm.
Step 3: Estimating a Sustainable Operating Margin in Stable
Growth:
- Analyse the firm's underlying business and its true competitors.
-
Break down the firm's current income statement to determine its actual
operating margin.
Step 4: Estimating Reinvestment for Growth:
- Recognise that young firms need to reinvest to foster growth.
-
Calculate expected growth using the formula: Expected growth =
Reinvestment rate * Return on capital.
Step 5: Estimating Risk Parameters and Discount Rates:
-
Traditionally, risk is perceived as a negative concept involving danger
or hazard.
-
However, risk has both negative (danger) and positive (opportunity)
aspects.
- Risk is often measured using the term "beta."
5. Valuation By Stage Method:
By assessing the popularity and success of similar products in the market,
investors can determine the value of a startup. This method provides a
direct and efficient approach to estimating the startup's valuation by
considering the
performance and valuation of comparable companies and
their products.
6. Venture Capital Method:
Primarily applicable to startups seeking funding, the Venture Capital
Method calculates the
expected return on investment for investors. This method
entails calculating the startup's pre-money valuation while considering
the venture's predicted growth and possible profitability. It aids
entrepreneurs seeking funding in analysing investment options.
In this, the first stage is to assess your startup's exit
multiple and establish its terminal value. An exit multiple is one of the
strategies used in the discounted cash flow calculation to compute the
terminal value.
Then, compute the predicted ROI. To calculate your
post-money valuation, divide the exit value by the ROI. Subtract the
investment amount you're seeking for from this figure to establish your
pre-money worth. You must invest the pre-money valuation today in order to
obtain the terminal value.
7. Book Value Method:
The Book Value Method evaluates the worth of a startup by considering the
total value of the company's assets. Unlike previous
methodologies, this strategy does not include analysing profits and
instead focuses entirely on the startup's actual assets.
8. Risk Factor Summation Method:
The Risk Factor Summation Method combines a thorough examination of main
risk factors that determine a startup's profitability.
These factors include, among others, management risk, sales and marketing
risk, market popularity risk, milestone accomplishments, legal risk and
capital and funding risk. By assessing these factors collectively,
investors can gain insights into the potential profitability of the
startup.
9. Relative Valuation Method:
Relative valuation determines the value of a company by comparing it to
similar companies or companies with similar features.
The first step is to discover peers who share comparable characteristics.
Next, look for key multiples such as EV/EBITA, P/E ratio, EV/Revenue and
EV/EBIT. To get the value, multiply the numbers by the mean or median of
the multiples. It benefits investors in the following ways:
-
Screen and shortlist equities to create a list of potential new
investments.
-
Determine whether a current investment is overpriced in comparison to
its peers and should be sold.
There are two approaches to relative valuation:
The Comparable Company Method: The current share prices
of comparable companies on the market are utilised to evaluate the value
of a startup.
Precedent Transaction Method: The price paid for
comparable companies in the past is used to evaluate a company's value
using the precedent transaction method.
10. Berkus Method:
The Berkus Method takes into account multiple aspects to
determine the startup's value. Factors such as the
quality of management, product/service excellence, market acceptance,
strategic partnerships, advertising strategies and projected
sales
contribute to the overall valuation. Each factor is associated with a
specific monetary value, enabling a comprehensive evaluation of the
startup's worth.
By utilising these accurate and detailed valuation methods,
StartupFino provides a comprehensive analysis of startup
companies, enabling investors to make informed decisions about potential
investments.
Reasons to Consult a Professional Valuation Consultant like StartupFino
There are certain compelling reasons why startups should engage the
services of an external valuer for their valuation needs. These include:
Exit Strategy Planning:
- Set a baseline for the company before selling it.
-
Develop a strategy to improve profitability and increase value as an
exit strategy.
Buy/Sell Agreements:
- Establish a mutually agreed value for partnership firms or LLPs.
- Prevent future disputes among partners.
Shareholder or Partnership Disputes:
-
Independent business valuation helps in fair settlement of ownership
interest when an owner decides to leave a partnership.
Mergers and Acquisitions:
-
Determine if the price demanded for buying or merging with another
company is fair.
Determining the Annual Per Share Value of an Employee Stock Ownership
Plan (ESOP):
-
Value shares of ESOP annually to meet specific requirements and
establish a fair stock price.
Funding:
-
Objective valuation assists in raising capital from banks, venture
capitalists and other investors.
Litigation Support:
-
Objective appraisal aids in pretrial settlement or strengthens a
situation where business valuation is the main issue in a trial or
arbitration.
Gift Tax Planning:
-
Accurate and documented valuation helps avoid doubts and complications
in gift tax planning.
Estate Planning:
-
Determine the value of the business to adequately plan for future estate
tax liability and avoid burdening heirs with hefty taxes.
