“The Million Dollar Idea” - how to properly value a start-up
Why do you even need to value a startup?
To attract investment, to find a business partner, to understand how your project is developing or to find out the value of a startup in order to sell it.
A startup is a new venture that develops new ideas and technology in order to introduce a new product or service to the market.
This is why it is impossible to value start-ups in the same way as conventional businesses.
Valuing a start-up is not an easy task, as an investor needs to assess the potential of the team of specialists working on the start-up.
Financial analysts use different methods to evaluate a startup. We will discuss the most popular ones.
This is an approach created by American venture capitalist and business angel David Berkus. He proposes to evaluate five key components of a startup's success, and on that basis evaluate the whole startup:
- Underlying value (idea),
- technology (prototype),
- execution (team of specialists),
- strategic market relationships (what are the risks, competitors)
- production and subsequent sales
Disadvantages of this method: A very subjective evaluation.
This approach involves taking into account all costs and expenses at all stages related to the start-up and development of the product, including the cost of purchasing physical assets, specialist salaries, third-party services, advertising and promotion expenses, etc.
The disadvantage of this method is the inability to take into account intangible values of the startup: idea, startup initiative, brand, reputation. But this method is a good basis for other valuation approaches.
Profit rate method
The method is based on forecasting future cash flows of the startup.
The rate of return on investment is also estimated, which is used to determine how much the projected cash flow is worth.
The disadvantage of this method is that it does not evaluate the startup itself, but the efficiency of the investment. But this is exactly what your investor will be interested in.
A very common method of evaluating a startup against similar deals or venture investments.
Disadvantage: startup valuation can change significantly depending on market conditions.
Client-centric valuation method
This method is the most accurate, as it includes important evaluation metrics - customer acquisition, retention and monetization.
This approach evaluates a startup by using analytics to reveal how well the company is attracting new customers and retaining and monetising existing customers. It then inserts this information into a standard cash flow valuation model to arrive at a more accurate estimate of the startup's value.
Information on other similar companies is often needed to evaluate a start-up. Investors and business partners will research competitors and companies in your industry to better understand how your start-up fits into that market.
As you dive into the calculation tables, don't forget about the people, because it is the team that makes your startup what it is.