Methods of Startup Valuation
There are different methods to calculate the valuation for new business. Some of them are simple, while most of them are based on several qualitative variables and statistical analysis. It is necessary for an entrepreneur to understand the most appropriate valuation method and then calculate the worth accordingly.
1. Venture Capital Method (VC Method)
The venture capital method allows a startup to evaluate the forecasted terminal value by establishing the return to be paid to an investor. It is well-suited for the pre-revenue startups involving pre-money valuation. The pre-money valuation is calculated by subtracting invested capital from post-money valuation, in which the post-money valuation is obtained by dividing terminal value with an expected return. It is the simplest method to calculate startup value. This method is suggested by most reputed fundraising for startups in India.
2. Cost to Duplicate Method
This approach is very realistic as it calculator the net worth of all the hard assets of a startup and determines the cost to replace it and re-establishing it somewhere else. The investor will fund the amount that is needed to duplicate that particular business. However, it is done for the time being and does not include the future asset valuation anyway.
3. Berkus Method
Berkus method evaluates a startup based on the business idea, the prototype of products or services offered, quality of the management team, strategic relationships or alliances, and sales forecasting. Each of these criteria is associated with a certain amount of money.
4. Discounted Cash Flow (DCF) Method
This type of valuation method for a startup is used for estimating the overall value of the investment on the basis of the future cash flows.
DCF analysis is known to analyse the respective attempts towards getting an idea of some current investment –depending on the projections of how much money it is going to generate in the future.
Preparing the Valuation under Discounted Cash Flow Method
Step 1:Assess the firm’s Current Standing: What are the firms current year revenge
What is the cash Burn rate of the company
Step 2: Estimate Revenue Growth This can be identified in the following ways
o ·Past growth rate in revenues at the firm itself
o Growth rate in the overall market that the firm serves
o Barriers to Entry and Competitive Advantages possessed by the firm
Step 3: Estimate a Sustainable Operating Margin in Stable Growth This can be identified in the following ways
• Looking at the underlying business that this firm is in, consider its true competitors.
• Deconstruct the firm’s current income statement to get a true measure of its operating margin
Step 4: Estimate Reinvestment To Generate Growth To grow, firms have to reinvest, and this principle cannot be set aside when you are looking a young firm
Expected growth = Reinvestment rate *(multiplied) Return on capital
Step 5: Estimating Risk Parameters and Discount Rates Risk, in traditional terms, is viewed as a ‘negative’. Webster’s dictionary, for instance, defines risk as “exposing to danger or hazard”.
But has two facets one is “Danger” and the othe is “Opportunity”
Risks are termed as BETA
5. Scorecard Valuation Method
It utilizes the comparison of the pre-money valuation of the startup by incorporating a scorecard. The average pre-money valuation of the startups in a region is calculated giving importance to certain criteria such as the size of the business, the strength of the central team, the technology used, competition, marketing channels, and investment options. The scorecard is made by assigning factors to each element and comparing it with a standard.
This the most the used method in valuation , the components being the Weighted Average Cost of Capital , Beta being the risk factor , Cost of Equity and other factors that are used to determine the present value of future cash flows
6. Risk Factor Summation Method
There are 12 factors that are considered for the evaluation of the worth of new business. These factors are - business stage, management team, political risks, manufacturing risks, sales and marketing, capital funding, competition, technology, litigation risks, reputation related risks, and potential lucrative risks. Every factor is analyzed as positive, negative, and neutral to determine the valuation. The registered valuers for valuation in India combine this method with other valuation processes for business valuation.
7. Business Stage Valuation
A quick range of validation needed by angel investors and venture capital firms in order to fund a startup. The business stage valuation method evaluates various stages of funding with respect to the risks of investing in a startup. It is based on the estimated company value, stage of development, business idea, management team, product prototype, and strategic alliance or partners in the business venture.
8. Probability Methods
There are some other probability methods such as the comparables method, the first Chicago method, and the book value method. They are all based on assumptions and future probability, without any mathematical or data analysis. The startup valuation is done based on best-case, worst-case, and normal case scenarios.
9. Startup valuation revenue multiple