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How to do a Startup Valuation using 8 Different Methods
How Much is Your Idea Worth? Explore 8 Ways to Find Out
The Founders
August 30, 2024
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So you've built a fantastic startup, but how much is it actually worth? Valuation is a crucial step for attracting investors, securing funding, or planning an acquisition. But with so many methods out there, it can feel overwhelming. Worry not!
Today we will break down 8 common startup valuation methods, and make the process more and accessible.
"There's a very famous saying: If you have to ask how much it costs, you can't afford it. But that doesn't apply to startups. You absolutely need to know how much your startup is worth." — Marc Andreessen, Co-founder of Andreessen Horowitz
Method 1: The Berkus Method: Simple & Effective (for Early-Stage Startups)
Imagine your startup is a dream car. The Berkus method, created by venture capitalist Dave Berkus, assigns a value based on key milestones achieved.
The Berkus Method values a startup based on qualitative assessments of five key success factors, each assigned a monetary value up to $500,000. This method is ideal for early-stage startups with limited financial data.
Example:
Sound Idea: $250,000
Prototype: $200,000
Quality Management Team: $300,000
Strategic Relationships: $150,000
Product Rollout or Sales: $100,000
Total Valuation: $1,000,000
Method 2: Comparable Transactions Method: Benchmarking Success
This method involves comparing the startup to similar companies that have been recently acquired or funded.
Example: Let's say your food delivery app is looking for a valuation. You find a similar app that was acquired for $100 million with double your revenue. Considering you're in a slightly smaller market, you might estimate a valuation of $50 million.
Method 3: Scorecard Valuation Method: A Balanced Approach
This method combines quantitative data (like revenue and user growth) with qualitative factors (like team strength and market opportunity). You assign weights to different metrics and score your startup accordingly.
Example:
A scorecard might include factors like:
Monthly Revenue (20% weight)
User Growth (30% weight)
Team Experience (25% weight)
Market Size (25% weight)
By assigning scores and multiplying by the weights, you get a total score that can be translated into a valuation using a predetermined formula.
Method 4: Cost-to-Duplicate Approach: How Much to Build It From Scratch?
This method estimates the cost to replicate the startup’s assets from scratch. It’s more useful for asset-heavy businesses.
Example:
Technology Development: $400,000
Patents and IP: $200,000
Product Development: $300,000
Employee Training: $100,000
Total Valuation: $1,000,000
Example: Imagine your e-commerce platform has a custom recommendation engine that cost $500,000 to develop. You also have a highly trained marketing team and brand recognition worth an estimated $1 million. Your cost-to-duplicate valuation could be around $1.5 million.
Method 5: Risk Factor Summation Method: Accounting for the Unknown
This method identifies potential risks (e.g., competition, regulatory changes) and assigns a probability and impact score to each. The scores are then used to adjust a base valuation derived from another method. Each risk factor can add or subtract up to $500,000.
Example:
Let's say your social media app has a base valuation of $10 million. You identify a high risk of a competitor launching a similar product (probability: 70%, impact: -30%). This would translate to a valuation reduction of $3 million, resulting in an adjusted valuation of $7 million.
The 12 common risk categories are as follows:
Management
Stage of the business
Legislation/political risk
Manufacturing risk
Sales and marketing risk
Funding/capital raising risk
Competition risk
Technology risk
Litigation risk
International risk
Reputation risk
Potential lucrative exit
Method 6: Discounted Cash Flow (DCF) Method: Projecting Future Earnings
Businesses can also be valued using the Discounted Cash Flow (DCF) Method. You might need to work with a market analyst or an investor to do this.
Here's how it works: you estimate your future cash flows and then apply a discount rate, which is the expected return on investment (ROI). A higher discount rate means the investment is riskier, so your growth rate needs to be better.
The basic idea is that investing in startups is riskier than investing in established businesses that already make steady money.
Method 7: Venture Capital (VC) Method: A Growth-Oriented Approach
This method is often used by venture capital firms and is great for valuing a startup before it has revenue. It shows how investors think when they plan to sell the business in a few years.
You’ll use two formulas for this valuation:
Anticipated Return on Investment (ROI) = Terminal Value Ă· Post-Money Valuation
Post-Money Valuation = Terminal Value Ă· Anticipated ROI
First, you calculate the terminal value, which is the expected selling price after the VC firm invests. You can estimate this using revenue multiples for your industry or the price-to-earnings ratio.
Next, determine the anticipated ROI, like 10x. Use these values to find your post-money valuation. Finally, subtract the investment amount you’re seeking to get your pre-money valuation.
Method 8: Book Value Method: The Assets on the Books
This method simply adds the value of a company's assets (cash, inventory, equipment) and subtracts its liabilities (debt). It's less relevant for startups with limited tangible assets and focuses more on future potential.
Thank you for reading The Founders' Weekly. Let's continue learning and building strong customer relationships together!
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