As an entrepreneur, at some point you’d be faced with the question, how much is your startup worth? There are many reasons why you should know the worth of your startup but the most common reason is to attract investors. The process of determining the worth of a startup is called Startup Valuation. Before trusting you with their money, investors need to know how much your company is worth. But unlike matured businesses with the numbers to show their value, startups usually don’t have any financial history. This is why knowing the value of a startup can be very tricky. However, there are techniques used in valuing a startup but we will talk about that later. Although startup valuation is not an exact science, there are factors that are often considered when valuing a startup. These are;

1. The development stage of the product or service
2. Proof of concept 
3. The credibility of the CEO and team behind the startup
4. Sales
5. Strategic relationships and customer base
6. Valuation of similar startups and peers 

Using these factors, you can arrive at a near-perfect value for your startup which is excellent. Because if you overvalue your startup, you could drive away potential investors. On the other hand, if you Undervalue your startup you would be giving away a lot of equity for far less than its worth. Even with the best valuation, nothing is guaranteed because a lot can happen that would change the course of the business and ruin expectations. Yet, it is better to have a valuation that is nothing at all. 

Startup Funding 

At some point in the life cycle of a startup, an entrepreneur will need to raise funds. All startups go through four fundamental funding stages; 

Seed funding

This is the first round of funding or capital an entrepreneur will raise to start a business. Seed funds are small and usually come from people who know the entrepreneur. However, Angel investors can also get involved in the seed funding stage. In exchange for investing in the startup, the entrepreneur often gives a percentage of the equity to the investor. Seed capital isn’t fixed but on average it could range between $500,000 to $2,000,000.

Round A Funding

After the seed funding round, the next is Round A funding or Series A funding. Round A funding is required when a startup is ready to push an idea to the market. At this point, a company is expected to have a great idea and a good strategy for converting the idea into profits. Round A funding can be as high as $10 million to $24 million depending on the valuation of your company. At this stage, venture capitalists are the main investors hence the huge amount of money involved. 

Round B Funding

 After establishing a successful product in the market, the next step is expansion. Round B or Series B funding is used to grow the company. Startups are going from being local players to major players in their niche industry. Before Round B fundings, startups are expected to have a good history of generating revenue, and this is shown in their valuations which can be as high as $60 million. With this funding, a startup can hire more staff, make necessary acquisitions or venture into new markets. 

In summary, valuing a startup is necessary if it is to acquire the funds needed to grow into a successful business. 

7 Methods you can use to value a startup

Venture Capital Method

This method is used in pre-revenue startup valuation. That is when the startup is yet to generate any revenue. It was described in 1987 by Harvard Business School professor, Bill Sahlman. The method uses two formulas to determine the value of a startup and these are; 

1. Return on Investment (ROI) = Terminal or Harvest Value ÷ Post-Money Valuation
2. Post-Money Valuation = Terminal Value ÷ Anticipated ROI

Berkus Method

The Berkus method is more of guesswork and is mostly used by experienced investors who have good knowledge of the market. In this method, a certain value is assigned to every stage in the growth life cycle of a startup. 

Scorecard Valuation Method

This method uses the average pre-money valuation of other startup businesses in the area to determine the value of a new startup company using a scorecard. This valuation method has three steps; 

1. Find out the average pre-money valuation of pre-revenue startups and businesses in the same market and industry as the target startup 

2. Apply a rating to each quality of the company as shown below;

1. Strength of the Management Team – 0-30 percent
2. Size of the Opportunity – 0-25 percent
3. Product/Technology – 0-15 percent
4. Competitive Environment – 0-10 percent
5. Marketing/Sales Channels/Partnerships – 0-10 percent
6. Need For Additional Investment – 0-5 percent
7. Other – 0-5 percent

3. Multiply the sum of the percentages by the average pre-money valuation of similar companies 

Risk Factor Summation Method

The risk factor summation method uses 12 elements in its valuation. Each element is assigned a value based on the pre-money valuation of similar pre-revenue companies in the same market. The value assigned to each element ranges from +2 (meaning a very positive growth indicator)  to -2 (a very negative growth indicator). While 0 is neutral. The 12 elements are;

1. Management
2. Stage of the business
3. Legislation/Political risk
4. Manufacturing risk
5. Sales and marketing risk
6. Funding/capital raising the risk
7. Competition risk
8. Technology risk
9. Litigation risk
10. International risk
11. Reputation risk
12. Potential lucrative exit

Cost-To Duplicate Method

This valuation method only considers the present value of the company based on its current asset and how much it would cost to make a duplicate of such a company. It doesn’t take into consideration the future worth or value of the company. Validating a company this way is not the best for the entrepreneurs but it helps the investors stay within the acceptable risk. This is why the cost-to-duplicate method is considered a “lowball” valuation of the company’s worth. 

Discounted Cash Flow Method

The strength of this method of valuation lies in the accurate prediction of future cash flows. The future cash flow of the company is stacked against the expected ROI to determine its worth. A high discount rate is used in this method since the company has a high risk of failure. 

Valuation By Stage Method

As the name implies, this valuation method is based on what stage the company is at. To make an accurate estimate, investors use the funding stage to predict the amount of risk. A company that’s at the seed funding stage will have a lower valuation than a company at the Round B funding stage. 

Conclusion 

Startup valuation is important because it helps the entrepreneur determine how much equity will be relinquished for an investment. It also helps the investors know what ROI to expect from their investment. It is not an exact science and most aspects of a startup valuation are based on market predictions (basically guesswork). However, it remains one of the most effective ways of knowing what stage a startup is in its lifecycle. 

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