Valuation is essential for any Startup
In today's entrepreneurial environment, there is a competitive nature amongst startups to get their companies off the ground. The ultimate goal of any new business owner is to be successful and that starts with funding and partnerships with other entrepreneurs. But what happens when your startup isn't quite ready for investment? Investors want to see some proof that your vision can become reality before investing money into something that could fail miserably. This is why it's important for startups or emerging businesses to carefully evaluate their company's potential and make sure they have what it takes before going out looking for investors.
Founders of early-stage startups need to understand the fair market value of the businesses they are building, but many entrepreneurs do miss out on how they think about valuations in an investor-friendly way. Understanding valuations and getting it right is critical for both entrepreneurs and investors.
Valuations are factors used by investors to determine the future potential of a company and its likelihood of bringing in profit.
Why is valuation important for Investors
Before you invest in a company, it's important to know how to value it. Choosing the correct valuation method is crucial for your analysis. Pick the wrong one, and you could be left with a false impression. A valuation is a business appraisal that is used to have an objective and unbiased opinion of the company's value.
How to Value a Company and build your portfolio? Developing an investment thesis is a key part of the equity valuation process. It requires finding data and analyzing the potential pitfalls and pros of your proposed investment. Valuing a business requires that you strike the right balance between being too conservative and being overly aggressive.
How To Value Your Business
Valuation is science - With multiple methods depending on the startup type, stage of development, investor types and various other factors. In short, valuation is about weighing one's expectations with the tangible numbers that we derive from the business.
There are two ways to determine the valuation of an early stage company. The first includes direct comparison. This method compares similar companies that have been acquired in the past and uses them as a reference for establishing a probable value for related entities. This approach takes into account the fact that each entity is unique and has its own value, but it’s important to consider that there are cases when there aren’t many or any similar companies or they have been acquired very recently, causing their valuations to be irrelevant.
In the other, besides the direct reference, various other factors like the sustainability of founders, capitalization and dilution of investment, use of equity as a competitive performance evaluation will also be calculated. To calculate the value of an early stage startup, you must consider various factors such as market, customers, funding, and team.
Let's get into the nitty gritty on how to actually calculate your business's value.
Berkus Method – This is one of the simplest method used by many early stage investors as well as first time investors. In this method a specific band of value is allocated to –
· Idea (basic value, product risk)
· Prototype (reducing technology risk)
· Quality Management Team (reducing execution risk)
· Strategic relationships (reducing market risk and competitive risk)
· Product Rollout or Sales (reducing financial or production risk)
After a value is assigned an aggregate of this value is defined as a derived valuation of the business
Bill Payne Method - A scientific scorecard based mechanism with a distributed weightage and rating based valuation method. In this the business is rated on the following parameters.
· Strength of Entrepreneur and Team
· Size of the Opportunity
· Product/Technology
· Competitive Environment
· Marketing/Sales/Partnerships
· Need for Additional Investment
Each of these parameters will conclude a score after applying the weight and rating. This score then becomes the multiplying factor over the average pre-money valuation.
Besides the above methods there are proprietary scorecard methods like StartupBay Scorecard etc which are customized with more data on specific sectors, markets and technologies.
In Conclusion
When you're ready to take your company to the next level, it's important that you have a realistic, reasonable appraisal of its current value. When making decisions about company value, management needs to understand the right method to use.
A dollar in equity is not equal to a dollar at a financial institution. The time-value of money represents how every dollar invested over a certain period of time will be worth more than a dollar today.
Through this discussion we have tried to gain a better understanding and methodology around how to build a strong valuation process to get the right value of the equity - no matter if your startup is Physical or digital.