Startup Valuation – Methods And Techniques to Determine the Pre-money Valuation of Startups

Everything is a kind of art rather than science in the world. Because the application of a variety of things varies according to the individual and the circumstances. And when it comes to the “Startup Valuation” or “Valuation” of a business it is also more of an art than science. Valuation actually refers to the monetary estimation or approximation of something.

Startup Valuation - Methods And Techniques to Determine the Pre-money Valuation of Startups

Why Does Valuation Matter So Much…?
Well…!!! If the founders or entrepreneurs desire to raise money for their startup, then they have to put the value in front of the investor. So that investor can calculate the liquidity of the investment. Investors consider a lot of factors like the potentiality of the industry, team’s reputation, pre- valuation revenues, distribution channel, traction etc. One should know that valuing a startup is quite different than that of a well- established company. Because a startup is valued highly on the qualitative attributes or metrics.

Components Considered While Valuation:
Valuation is a process where the monetary worth of the company is determined to have a clear and precise idea about the company. Depending upon the nature and characteristics of a company different valuation technique’s are adopted. Generally, the following components are considered while startup valuation:

  • The capital structure.
  • The company’s management.
  • The market value of assets.
  • Prospects of future earnings.

Startup Valuation - Methods And Techniques to Determine the Pre-money Valuation of Startups

Methods And Techniques One Can Adopt For Startup Valuation:
The founders or entrepreneur can adhere to any of the following listed methods of techniques to come out with a fair value:

The Asset Approach:
This is considered as the most subjective and straightforward method for the valuation of a startup. So when a startup begins it does not have many asset in hand. But then, the valuer should make sure that he includes each and everything in the calculation under this approach like office space, equipment, furniture, development cost, tools, products, etc. to come out with an appropriate value.

Venture Capital method:
This method falls on the court of the investor and it reflects their process with the company. They plan for an exit within 3 to 7 years, so the expected exit price out of their investment is calculated. And then after which post- money valuation is done on the basis of investors time, effort , action and risk.

This method is used in the valuation of pre- revenue companies. Because it is easier to estimate approximate values for an exit when certain targets are achieved.

Discounted Cash flow (DCF):
This method estimates the free cash flow generated in the future by a specified company and then the valuers discount them to derive the present or say today’s value. The discounting value, usually used as the estimation is the weighted average cost of capital.

DCF is more reliable because it helps the company estimate the value of potential investments. They tend to generate values more than the initial investment.

Risk Adjusted NPV:
The Risk Adjusted Net Present Value (NPV) applies the same principle just like DCF. But then, the future cash flow is the risk adjusted to the profitability of it actually occurring. The probability of the cash flow occurring is also known as the ‘success rate’. This method helps estimate the compounds and products in particular and is best suited for pharmaceutical and biotech industry.

Market Comparable method:
This method helps to estimate the valuation based on the market capitalization of a comparable listed company. This method is quite very simple to apply and valuate. They make use of different key ratios like R&D investments, earning, sales etc which helps to estimate the value of the company.

Comparable Transaction Method:
This method does something different it aims to value the entire company with a similar sized private company and using a different key ratio. This method is very simple and quick. The values of the target company are either based on the M&A deals or the comparable investment.

Decision Tress Analysis:
This method helps to estimate the future outcomes by applying some probability approximates to a particular idea or decision. This method involves so many branches where each branch is a decision to be made.

They give a graphical representation of strategies, decisions and option that has to be taken to achieve the desired goal or target.

What Would Be The Best Valuation At The Initial Stage ?
Valuation should definitely be appropriate if not accurate. Going for higher valuation at the initial or seed stage would lead to a further hike in valuation in the next round.

If you spend all your money with the motto of growing fast. Then you need to put more and more each and every time you perform the startup valuation. But if something goes wrong, then you will have to face misfortune.

But then, One can try this. You can spend less and raise money whenever you need. Doing this would help you have slow and steady growth. So go steady with little would help you more and better.

Valuation is all about how much money you actually need. So keep in mind that you need to run your team, product and traction and have at least 6 months of a runaway. So make sure you evaluate these aspects appropriately and grow.

Therefore, consider all the market forces and values in a favorable manner to have a better valuation for your company.