Early stage valuation is like trying to find out the potential of a six year old. It works by starting to look at what he or she is at the moment - an average child, a genius or any of that for example. Imagine that you see someone of this age and you think to yourself, “what could they become?” 

To answer this question, you will look at their current performance, their background, their parents and sponsors. You would ask yourself, “how are they performing in their class or current level?”, “are they stable or do they have disabilities that could hinder them?”, “who are their parents and what is their status or influence?” 

The exact same thing happens in the early stage valuation where a young business is considered for its present worth and its possible future value. This valuation considers the performance statistics of a company in terms of revenue, cash flow, risks etc., their standing with other businesses and high-value stakeholders, and the quality of their intangible assets such as brand or patent rights among other things. 

Also Read: Everything You Should Know About Startup Valuation 

What is early stage valuation?

Startup valuation is the process of estimating the value or worth of a startup. Early stage valuation, therefore, simply refers to valuation being done while the company or startup is still relatively new. Typically, this happens within a few months of the company’s existence. 

Why is it so difficult to value an early-stage startup?

Early stage startups are a valuation pain. The reason lies in the fact that they are relatively new and have little activity. This little activity implies that there will be an insufficient or, sometimes, an unsatisfactory amount of revenue, unit sale, cash flow, and other data necessary for performing any kind of valuation. 

Why is it important to value an early-stage startup?

Why perform an early stage valuation? Why not allow a startup to grow to its full potential before estimating its worth? Well, an early stage valuation has positive sides. Some of the major importance of this kind of valuation include:

Value Projection and Estimated Future Worth:

Early stage startup valuation helps founders and investors project the value and potential of a startup right from its early days. Investors use this in making a quick decision on whether to keep an eye on a business or not. This is also done before a potential acquisition when investors want to get in early on a company. This is not just about the future 

Quick Business Adjustments:

Once a startup turns out with a low market valuation, the next step would be to figure out ways of improving this value. There are a lot of things one can do to get going here and luckily for entrepreneurs, these options are relatively cheap. They include improving upon existing strategies, setting more realistic goals, partnering with industry giants, recruiting or training a solid team among others. 

Also Read: The 6 Phases of a Startup

Methods used in early stage valuation

As we’ve mentioned, early stage valuation is difficult for the very reason that early stage companies don’t have enough data for valuation. Despite this challenge, however, it is still possible to value a new company. Here are the methods used to achieve this:

Discounted Cash Flow Method:

A company’s cash flow in the future is estimated using the Discounted Cash Flow method of valuation. 

Future Valuation Method:

Future valuation method helps shareholders and investors understand the possible return on investment (ROI) of a startup. 

Cost-to-Duplicate Method:

The cost-to-duplicate method of early stage valuation identifies the total cost of a business’s activities and resources. Its application is arguably limited to physical business assets and processes such as inventory, office complex, products, and production costs. 

Market Multiple Method:

Another way of performing an early stage valuation is using the market multiple method. This method simply values a company or startup which is similar in nature to the one requiring valuation. It then attributes the value of the first company to the second one. 

Risk Factor Summation Method:

Risk factor summation method of valuing an early stage startup or company is self descriptive. It involves assessing all the risks related to a business. This method first utilises any of the other methods for startup valuation. Once a value has been determined, the method then proceeds to estimate risks associated with the business and to calculate the final value after taking out the risks.  

Berkus Method: 

The Berkus method was developed by Dave Berkus. The American investor valued companies using five steps that include; determining their basic value, assessing their technology, assessing their execution, looking at their strategic market relationships, and finally, analysing their production and sales or output. 

Also Read: 18 Metrics to Check for Business Growth 

5 ways to improve the early stage valuation of your startup

Early stage valuation could easily put a startup in a negative light. This happens when the company is valued low. You would probably want to know if it is possible to salvage this situation and what to do about it. Here’s are some ideas for that;

Increase Profitability:

A valuable startup is one that generates good revenue or profit on operation and sales. By increasing profitability, you automatically increase the value of your company.

Increase Cash Flow:

The movement of cash in and out of a startup or business is termed cash flow. This creates an interesting statistic for both founders and entrepreneurs because heavy cash flow implies that a company is active and operational. 

Improve Operational Efficiency: 

Having a well organized and an efficient business operation is big stuff. It reduces waste of finance and material resources. Stakeholders find this attractive and more so, valuable. 

Maintain High-end Relationships: 

High-end associations and acquaintances between businesses improve each one of them. It means that a company which has been in contact with a reputable client or investor or which has a high reputation itself can benefit a new startup by simply associating with. 

Acquire Technical Knowledge:

One other way founders could boost their startup valuation is by acquiring the technical knowledge required to run their business. A huge knowledge gap reduces the valuation of a startup. This is because overall productivity is impacted when a company or business operates in a field it is not fully knowledgeable about.  

Wrapping up

If you pay good attention to what we mention here, you will likely move from being scared about an early stage valuation to being excited or even promoting it. Valuation exercises reveal a lot. And the positive side to it is that business owners get to understand the position of their business and what steps they need to take to change things. 

For example, a business that records low early stage valuation can begin developing improved products, hiring top talents, or associating with high-value companies to boost its value. In another instance, a business that scores high in early stage valuation can simply look out for ways to maintain this reputation. You can read more about regular startup valuations on our blog or learn more about building assets and securing fund which will all help you improve your business value.