Valuation of a startup is the critical stage a startup company looking for investment, or seeking to ascertain its worth must pass. From experience, valuation is a difficult subject for startups. Thus knowing how and what methods to use to confront it will certainly be a great source of strength for startup founders when negotiating with potential investors.
In this article, we are discussing various methods to evaluate the startup position of a business:
The venture capital method:
The venture capital approach is often used to assess pre-revenue startups by venture capital companies and angel investors. It’s a quick way to figure out how much a company is worth. Professor Bill Sahlman of Harvard Business School was the first to describe this strategy in 1987.
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In this method, we calculate the Pre/Post Money Valuation and Return on Investment by using the following formula:
- Post money Valuation= Terminal value ÷ Anticipated Return on Investment(ROI).
- Pre-money valuation = Post-money valuation — Investment
- ROI = Terminal value ÷ Post money Valuations
Example:
If we are starting a business with a terminal value of $2,000,000 and a 20X expected return on investment, and we are investing $100,000 for an effective cash flow, we get:
Hint: We may compute the terminal value by looking up average sales of established companies in the same industry (at the end of the projection period) and multiplying the figure by a multiple of two. In the example above, terminal value is $2m ×2=$4m
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- Post money Valuation = Terminal value ÷ (ROI)
Therefore, Post money Valuation = $4m ÷20X; which gives us $200,000
- Pre Money Valuation= Post money Valuation— Investment
Therefore, Post money Valuation =$200,000 — $100,000
Pre Money Valuation=$100,000
- ROI = Terminal value ÷ Post money Valuations
Therefore, ROI = $4m÷ $200,000=20
*All figures may quickly be computed using https://calculator-online.net/
Berkus approach:
Dave Berkus is a well-known professor who has invested in over 80 start-up businesses. Dave’s concept was first published in a book by Harvard’s Howard Stevenson in the mid-1990s, and it has subsequently been employed by Angel investors. In the Berkus method, we consider various key factors of starting a business.
A comprehensive assessment is done on the basis of these factors, and on these measurements, the valuation of the business is done. The Berkus method also said to be a “Stage evaluation method”
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The most recent Dave Berkus version, updated in 2009, begins with a zero pre-money valuation and then evaluates the target company’s quality in light of the following characteristics:
| Characteristics | Add to Pre-Money Valuation |
|---|---|
| Quality management team | Zero to £0.4 million |
| Sound Idea | Zero to £0.4 million |
| Working prototype | Zero to £0.4 million |
| Quality board of directors | Zero to £0.4 million |
| Product rollout or sales | Zero to £0.4 million |
Following the Dave Berkus method, if your early-stage business has a good management team, a working prototype, and sales, your valuation will be estimated at $1.2 million.
Note that the figures represent the maximum for each class, thus a valuation might be as low as $800,000 (or as high as $2 million). Dave further points out that his strategy was “created expressly for early stage investments as a way to locate a starting point without relying on the founder’s financial forecasts.”
The cost duplication method
In this method, we take into consideration all the costs and expenses of the startup of a company and the development of the product. This cost involves the purchase of the physical assets, and the market expense. We need to evaluate various expenses and conversions and we can make estimations by using the metric conversion calculator. All these expenses are taken into consideration to determine a fair evaluation of a startup business. The duplication method has its limitations like estimating the companies future sales and revenues.
The future valuation multiple approaches
This method is used to estimate the future value of a new company in the near future. The most appropriate five-year projection is usually preferred. For example, we can make numerous future projections, such as forecasted sales and revenues over the next five years; as well as cost and expenditure projections for product and services. All of these forecasts and based on estimates.
The discounted cash flow approach
The discounted cash flow (DCF) method is used to calculate the expected cash flow in the future. The rate of return on investments is calculated using a discounted rate. The DCF cash flow project determines what your firm is worth after a specific value. When you are just starting out, a high discount rate is frequently employed, as there is a high risk factor in a startup business. The DCF method is extensively used in industry.
Discounted Cash Flow (DCF) Formula
The formula for DCF is:
The objective of a DCF analysis is to calculate how much money an investor would get from a given investment after accounting for the time value of money. Because money may be invested, the historical value of money assumes that a dollar today is worth more than a dollar tomorrow. As a result, a DCF analysis is appropriate in any case where a person is spending money now in the hopes of obtaining more money later.
Conclusion
Every startup business needs projections and speculations based on precise data and calculations. At Calculator Online, we use metric conversion methods for precision of data.
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Jennifer Linda writes from Lahore, and is always willing to offer information that conveys her knowledge of marketing, and business generally.
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