VC’s use various methods to calculate a Startups valuation.
To select a Startup Valuation method that is right for you, see ‘Selecting a Startup Valuation Method’
These are the brief descriptions of the primary Startup Valuation Methods that you can choose for your business:
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List of various methods to calculate a Startups valuation
- Berkus Method
- Risk Factor Summation Method
- Scorecard Valuation Method
- Discounted Cash Flow Method
- Comparable Transactions Method
- Book Value Method
- Liquidation Method
- First Chicago Method
- Venture Capitalist Method
- Leveraged Buyouts Method
- Sum of The Parts Method (SOTP)
The Berkus Method is a simple and convenient rule of thumb to estimate the value of a startup. First, you have to know how much a similar startup is worth. Then, you assess how you perform in the 5 key criteria for growing startups. This will give you a rough idea of how much your startup is worth (pre-money valuation) and more importantly, what you should improve. The Berkus Method is meant for pre-revenue startups.
|Risk Factor Summation Method
The Risk Factor Summation Method or RFS Method is a slightly more evolved version of the Berkus Method. First, you determine an initial value for your startup. Then you adjust said value for 12 risk factors inherent to startup building. Initial value is determined as the average value for a similar startup in your area, and risk factors are modelled as multiples of $250k, ranging from +500k for a very low risk, to -500k for a very high risk. The most difficult part here, and in most valuation methods, is actualy finding data about similar startups.
|Scorecard Valuation Method
The Scorecard Valuation Method is a more elaborate approach to the startup valuation problem. It starts the same way as the RFS method i.e. you determine a base valuation for your startup, then you adjust the value for a certain set of criteria. Nothing new, except that those criteria are themselves weighed up based on their impact on the overall success of the project.This method compares the target company to typical angel-funded startup ventures and adjusts the average valuation of recently funded companies in the region to establish a pre-money valuation of a pre-revenue startup
|Discounted Cash Flow Method
If your startup works well, it brings in a certain amount of cash every year. Consequently, you could say that the current value of the startup is the sum of all the future cash flows over the next years. And that is exactly the reasoning behind the DCF method. Option 1: you consider the business will keep growing at a steady pace, and keep generating indefinite cash flows after the n years period. You can then apply the formula for Terminal Value : TV = CFn+1/(k- g).Option 2 : you consider an exit after the n year period. First, you want to estimate the future value of the acquisition, for example with the comparable method transaction (see above). Then, you have to discount this future value to get its net present value. TV = exit value/(1+k)n
|Comparable Transactions Method
The Comparable Transactions Method is really just a rule of three.Depending on the type of startup you are building, you want to find an indicator which will be a good proxy for the value of your startup. This indicator can be specific to your industry: Monthly Recurring Revenue (Saas), HR headcount (Interim), Number of outlets (Retail), Patent filed (Medtech/Biotech), Weekly Active Users or WAU (Messengers). Most of the time, you can just take lines from the P&L : sales, gross margin, EBITDA, etc. The Comparables Transactions Method is meant for pre- and post-revenue startups.
|Book Value Method
The book value refers to the net worth of the company i.e. the tangible assets. The Book Value Method is particularly irrelevant for startups as it is focused on the “tangible” value of the company, while most startups focus on intangible assets : RD (for a biotech), user base and software development (for a Web startup), etc
Rarely good from a seller perspective, the liquidation value is, as implied by its name, the valuation you apply to a company when it is going out of business. Things that counts for a liquidation value estimation are all the tangible assets: Real Estate, Equipment, Inventory… Everything you can find a buyer for in a short span of time. All the intangibles on the other hand are considered worthless in a liquidation process (the underlying assumption is that if it was worth something, it would have already been sold at the time you enter in liquidation): Patents, copyright, and any other intellectual property, Brand recognition. Practically, the liquidation value is the sum of the scrap value of all the tangible assets of the company. For an investor, the liquidation value is useful as a parameter to evaluate the risk of the investment: a higher potential liquidation value means a lower risk
|First Chicago Method
The First Chicago Method answers to a specific situation: what if your startup has a small chance of becoming huge? How to assess this potential? The First Chicago Method deals with this issue by making three valuations: a worst case scenario , a normal case scenario , a best case scenario Each valuation is made with the DCF Method (or, if not possible, with internal rate of return formula or with multiples). You then decide of a percentage reflecting the probability of each scenario to happen. Your valuation according to the First Chicago Method is the weigthed average of each case. The First Chicago Method is meant for post-revenue startups..
|Venture Capitalist Method
As its name indicate, the Venture Capital Method stands from the viewpoint of the investor. An investor is always looking for a specific return on investment, let’s say 20x. Besides, according to industry standards, the investor thinks that a particular startup could be sold for $100M in 8 years. Based on those two elements, the investor can easily determine the maximum price he or she is willing to pay for investing in any startup, after adjusting for dilution.. The Venture Capital Method is meant for pre- and post-revenue startups
|Leveraged Buyouts Method
A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money to meet the cost of acquisition. A leveraged buyout (LBO) is an acquisition of a company or a segment of a company funded mostly with debt. A financial buyer (e.g. private equity fund) invests a small amount of equity (relative to the total purchase price) and uses leverage (debt or other non-equity sources of financing) to fund the remainder of the consideration paid to the seller. The LBO analysis generally provides a “floor” valuation for the company, and is useful in determining what a financial sponsor can afford to pay for the target and still realize an adequate return on its investment
|Sum of The Parts Method (SOTP)
Sum-of-the-parts (“SOTP”) or “break-up” analysis provides a range of values for a company’s equity by summing the value of its individual business segments to arrive at the total enterprise value (EV). Equity value is then calculated by deducting net debt and other non-operating adjustments. For a company with different business segments, each segment is valued using ranges of trading and transaction multiples appropriate for that particular segment. Relevant multiples used for valuation, depending on the individual segment’s growth and profitability, may include revenue, EBITDA, EBIT, and net income. A DCF analysis for certain segments may also be a useful tool when forecasted segment results are available or estimable.
We have these Startup Valuation Methods, But ultimately the Startup receives a valuation that an investor is willing to pay and an entrepreneur is willing to accept. Just like in liquid public markets, a company is worth per share what the last person paid for the last share of stock purchased.
We recommend using multiple valuation methods and then bringing them all together to build a valuation range. Within that range, use qualitative factors (such as: market, management team) to assess the valuation of your business and narrow down the valuation range.
It’s important to be able to defend your valuation, and sometimes to compromise on it.