When seeking funding from an investor, start-up business owners must determine the value of their company. The challenge here is that your organization most likely doesn’t have any hard facts or revenue figures on which to base its value. Consequently, an estimation must be made. This has resulted in the creation of many business valuation methods to improve the accuracy of these guestimates.
It’s advisable to use several methods when determining the value of your start-up to arrive at an average valuation. Your average valuation is important because all start-up valuation methods are based on predictions and guesswork while none of them are scientifically or mathematically accurate. Using this approach will also make it easier to reach agreement with investors around the value of your business to calculate ROI and other key numbers important to investors.
Key factors considered when valuing a start-up
There are many positive and negative elements considered when estimating the value of a start-up.
Positive Factors include:
Traction – Showing that your company has customers is one of the biggest factors of proving a valuation. For example, having 100,000 customers gives you a good chance of securing $1 million in funding.
Reputation – Start-ups with owners who have a history of running successful businesses or having great ideas as well as products, processes or services that have already earned a good reputation help you get a higher valuation even when there isn’t traction yet.
Prototype – Having a prototype that exhibits your product or service is helpful.
Revenues – Having revenue streams, such as paying subscribers, make it easier to estimate the value of your company, especially if yours is a business to business start-up.
Supply and Demand of funding – When there are more business owners seeking funding than there are investors willing to invest your business valuation may be affected. This also involves how desperate a business owner is as well as how much investors are willing to pay.
Distribution Channel – Having effective distributions in place positively impacts start-up values where not having them is a disadvantage when it comes to estimated values.
Hotness of Industry – Start-up value is positively influenced by being part of a booming industry, making investors willing to invest more.
Negative Factors include:
Poor-performing Industry – Start-ups in industries with recent bad performance often find it difficult to attract investors with the exception of those who are comfortable profiting from down markets.
Low Margins – Start-ups selling low-margin products or in industries that tend to have low margins may be less attractive to investors.
Competition – Being in a highly competitive industry where competitors are well established may make it more difficult for a start-up to attain funding.
Management Not up to Scratch – If a management team of a start-up is incomplete or the team’s members don’t have an established track record it may be viewed negatively by potential investors.
Product – A product that doesn’t function properly or is perceived as unpopular make it more difficult to get funding.
Desperation – Start-ups seeking investors because they are almost out of money come across as poor financial planners, putting them in a poor position for gaining funding.
Popular Start-up Valuation Methods
There are various methods you can use to determine your start-up’s value. All of them are slightly different from one another providing a balance when estimating your average valuation. Below is a review of some of the most popular methods to consider:
This technique entails taking the value of a start-up’s hard assets and figuring out the cost to create the same start-up business in a different geography. Labour costs and how much labour was involved to accomplish key aspects are considered in this value estimation process. These include things such as programming in software.
Unfortunately, this method doesn’t take into consideration the future potential of the start-up, reputation of the company, popularity of the market or how well respected the brand has become in the marketplace.
Discounted Cash Flow Method
This approach is based on a calculation of how much a start-up’s cash flow will work against an expected rate of investment return. This calculation is based on an estimated amount of cash flow the company will produce. To complete the process, a higher discount rate is applied due to the greater risk a start-up carries when compared to a more established business.
The short-coming of this method is that it’s only as accurate as the market analyst’s ability to make valid assumptions pertaining to potential growth which is somewhat unpredictable for start-ups, especially during the early years.
This method involves looking at the valuation of other similar start-ups, then factoring in ratios and multipliers where they are dissimilar.
For example, a SaaS start-up acquired for $5,500,000 with 200,000 subscribers compared to a start-up that has 100,000 subscribers. The value per subscriber for the 200,000 subscriber SaaS would be $27.50 per subscriber, so the 100,000 subscriber start-up would be valued at $2,750,000.
The Book Value Method
This approach uses only the tangible assets of a company to determine its net worth. It doesn’t consider revenue or growth and is typically applied to start-ups when they are going out of business.
First Chicago Method
This technique looks at three possible scenarios – worst case scenario where the start-up bombs, normal scenario and best case scenario where the start-up takes off. The result is the business owner receiving three different valuations, one for each scenario.
Keep these factors and methods in mind when you’re ready to determine the value of your start-up. As you can see there could be several potential benefits to leveraging Lean methodology as you launch your start-up when it comes to valuation, writing your start-up business plan and approaching investors. It could give you the head start that you need if you’re in a highly competitive market!
If you’re at the right stage in your business, a start-up accelerator program may be just what you need next to grow. The question is, which one is best for you based on the stage of your company’s growth and development?
Developing a product and launching a start-up involves many risks. Reduce these risks by applying Lean methodology to your start-up: it involves working smarter, not harder, as you determine if your product or service is viable to support a sustainable business.