Have you ever wondered how to value a startup?
Whether you’re a founder, an investor, or a potential startup employee, the ability to value a startup is essential. What advantages would come from knowing that value?
Valuing a startup helps the owners, investors, and even employees know and understand the business’s value and limits. It can also assist in the decision-making process and aid in attracting investors and talent.
Knowing your business’s worth will enable you to negotiate better deals with interested parties.
Further, as a founder, you should realize that your company’s equity is limited. You wouldn’t want to give away employees or investors too much simply because you underestimated your business’s actual value.
Importance of Valuing Your Startup
Businesses need money to grow. Often, that capital needs to come from external investors.
But investors want to know if taking a chance on your startup is worth it. They aren’t giving you money out of the goodness of their hearts. Even friends and family invest in your company to generate a return.
Especially in these situations, valuation comes in handy. By comparing the current valuation with the projected valuation, investors can estimate the returns an investment in your company might bring.
A solid valuation can also help you negotiate better deals. Your assessment of the company’s value can be used as a bargaining chip to get the best deal possible for your business without leaving money on the table. If you can show investors what your startup is worth and why, securing financing for your startup might be easier.
Choosing a Valuation Method
There is no one-size-fits-all valuation method. The best choice for your company will depend on your location, size, type of startup, and complexity. Some valuation methods will fit your business better than others. Evaluating multiple ways is essential to find the most accurate valuation.
The more popular methods put a strong focus on selected metrics.
This approach looks at the past and present earnings of the company to determine its value. While this works well for companies with established steady income streams, it can be difficult for startups in the early stages.
Market Value Method
Market value methods are accurate ways of evaluating a startup. The method compares the worth of similar businesses and considers factors such as size, location, and type of business. Still, it can be challenging if you do not have any direct competitors.
This approach uses the assets and liabilities of the company to determine its worth. It’s most helpful for companies that are selling or liquidating.
Common Methods Used to Value a Startup
The Bekus Method
The Bekus Method is a mathematical formula that considers the value of a startup’s assets, liabilities, and earnings. It is an in-depth valuation method better used for more prominent startups.
Startups with a complex business model, multiple assets, and high liabilities should consider this strategy.
Comparable Transactions Method
The comparable transactions method looks at the market values of similar companies to develop a valuation. It considers things like income, profits, and other factors that could impact its bottom line.
The method is popular for startups because it is easy to use and doesn’t require massive financial data. It can also be used to evaluate early-stage companies.
The cost-to-duplicate approach examines how much it would cost to recreate the startup. If you go this route, consider factors such as inventory, equipment, and other assets.
This is a popular choice for startups because of its simplicity and the limited financial information needed. It is also beneficial to businesses still in the early stages of growth.
Discounted Cash Flow Method
The method considers the current value of a company’s future cash flows. It’s commonly used in businesses of all sizes to determine whether to invest in a new project.
The technique looks at how much money the startup will make in the future and discounts it back to the present day using an arbitrary cost of capital rate. Startups sometimes use the discounted cash flow method because of its simplicity.
Further, it’s also an effective method for evaluating future cash flows, especially related to new investments or acquisitions.
Risk Factor Summation Method
The method looks at the risks and rewards of investing in a startup. The technique considers factors such as the startup’s industry, location, and stage of development. It’s easy, doesn’t require much financial information, and works well for companies in the early stages.
Ready to Value Your Startup?
Valuing a startup can be difficult, but knowing your worth is essential for attracting investors and employees successfully. By understanding the different methods available, you can choose the most appropriate route for your company.
Determining your valuation can be challenging on your own. With the help of experienced startup financial experts, you can ensure you’re neither leaving money on the table nor scaring away potential investors with an inflated valuation.
Most startup founders would benefit from knowing their company’s value, and Founder’s CPA can help. Our extensive experience with startups can help you make informed decisions about your business. Contact us today to set up a free consultation and learn more!