Startup valuation is the estimated value of a business before it’s floated to the open market via an initial public offering (IPO). It determines how much money you can expect to raise from investors and is generally based on future potential rather than past performance.
Investors prefer to invest in companies whose value matches their expectations, and a company with a high valuation can expect more investment than companies with lower valuations. However, other factors affect investor decisions, such as profitability and business model viability.
There are several common approaches to finding your startup’s valuation. Which one is right for your business?
Common Startup Valuation Methods
When building a startup, you must understand how to value your company. Company valuation is an important step in the business life cycle. Several methods are available for determining your company’s value, so it’s critical to choose the right one for you.
The Bekus Method
This method was created by Dave Bekus, a venture capitalist, and mainly applies to startups that are yet to sell products at scale. A key objective is to assign dollar amounts to five early-stage startup success metrics. These include strategic relationships, sound ideas, quality management teams, prototypes, and product rollout.
Every existing metric adds to the company’s value by up to $500,000. This method helps investors and founders avoid faulty valuations based on projected revenues that only a few startups meet.
This approach aims to arrive at a valuation linked to the cost of building a similar business from scratch. It’s important to note that this method doesn’t necessarily consider intangible assets such as intellectual property or brand recognition.
Therefore, it should be used when valuing a business with more tangible assets or when there are no comparable companies to base an estimate on.
Comparable Transactions Method
This method is based on the valuations of similar publicly traded companies. Similar characteristics might include industry, size, product type, or geographic area, and you would use their market value as a proxy for your own company’s value.
It involves looking at other recently acquired or sold companies and determining the transaction price. Instead of using revenue projections, the comparable transactions method relies on relevant data points from past transactions to determine a company’s value.
Discounted Cash Flow (DCF)
This method evaluates the present value of a company’s expected future cash flows and discounts them back to the present using an appropriate discount rate. The discount rate considers a business’s risk and growth potential. Different businesses can with similar expected future cash flows have wildly different present values based on different risk levels and growth prospects.
Risk Factor Summation Method
This method is based on the idea that all startups have some level of risk. The higher the risk, the lower the potential investment return. The lower the risk, the higher the possible investment return.
The goal is to calculate what an investor should expect from a startup if everything goes perfectly with the business plan. But it also allows for flexibility if things don’t go as planned. This technique takes into account both the probability and magnitude factors of risk.
The RFSM is based on the idea that if an event has a low probability of happening, and if it does happen, it will not have much impact on your business. On the other hand, an event that has a high probability of happening could have a massive effect on your business. When valuing a startup, this method determines how much money you would lose if certain risks materialize.
Book Value Method
The book value method is the most basic way to value a startup. It’s based on the value of the company’s assets and liabilities, which are listed in its balance sheet. Ideally, a company’s book value is its net worth, calculated by taking total assets minus total liabilities (debt).
For example, if your company has $50,000 in liabilities and $100,000 in assets, its net book value is $50,000 (assets minus liabilities). A company with $200,000 in assets and no debts has a net book value of $200,000.
Navigating Startup Valuation
Startup valuation is an essential aspect of building a business, especially if you want to raise outside capital. Investors will use your startup’s valuation to determine your company’s worth and how much money they want to invest.
It’s also a good reference for a sale price when it comes time for an exit.
When choosing a valuation method, remember that no method is perfect, and none will give you an exact number. The purpose of each technique is simply to provide a range within which your company’s actual value falls.
With so many different methods available, choosing which is right for you can be challenging. Founder’s CPA’s startup finance experts can help you through this process. Contact Founder’s today for a personalized approach to choosing a method that suits your business!