Do you know how to calculate the business valuation of a startup? Many beginning entrepreneurs don’t understand what it means, and how to do the calculus.
That’s because, in today’s world, startups are attractive, but it’s not an easy job. In general, entrepreneurs start with an innovative idea and decide to bet everything on it.
By knowing how much your company is worth, you have the opportunity to explore all aspects of valuation when negotiating equity and investment values. However, the valuation does not represent an exact calculation, as it is the result of market perception and future projections.
In this article, you will find out some hints of how you can get a business valuation for your startup and get recognized in the market.
Why do valuation of a startup?
Valuation is a practice that aims to find out how much a company is worth. For this, a series of factors and evaluation criteria are taken into account. We can mention cash flow, equity, debt, sales volume, etc.
Everything will depend on the method chosen for the valuation.
However, other criteria are more subjective and are also usually considered during this process. For example:
- Size of the market in which the startup operates;
- Entry barriers and competitors;
- Partnerships;
- Level of operational innovation;
- The value proposition of the solutions offered;
- Degree of obsolescence of the solutions;
- Intangible assets (values, organizational culture, etc.);
- Business plan.
In the case of startups, which generally have little time on the market and a certain scarcity of data related to their financial history, more subjective information predominates when making the valuation.
However, startups at more advanced stages, more solidified in the market, and with significant cash, generation is perfectly capable of valuation using more traditional methods and based on more objective information.
When to do the business valuation?
Before understanding how to calculate a startup’s valuation, you must know the right time to do it. Thus, it can be performed at different times according to the desired objective. Many may think that the calculation of a startup is only made to seek a contribution of venture capital, for the sale of the company, or the purchase of corporate shares.
However, there are other reasons as important as these to calculate a startup’s valuation:
- Economic feasibility analysis
- Buying and selling businesses
- Investment entry
- Dissolution of companies
- Liquidation of ventures
- Merger, spin-off, and incorporation
You can do valuation when the startup needs to raise capital in the early stages, balance the business or advance to the next stage. Thus, it is important to understand that the valuation of a startup is not the starting point for negotiating with investors.
How important is business valuation?
For entrepreneurs, valuation allows them to negotiate fairly and also have an argument to seek investments. This is especially true for startups, where attracting investments is part of the business model.
In this case, valuation is fundamental, as it is an indicator of how attractive a startup is for the market. But that’s not all: internally, knowing the value of the business serves to project scenarios, which helps in management.
For investors, in turn, valuation makes it possible to find good business opportunities offered by the capital market. It also helps to avoid pitfalls such as risky and overpriced trades due to speculation.
How to calculate a company’s valuation?
There are several methodologies to calculate a company’s valuation. You can check them below:
1. Discounted cash flow
This is the most popular business valuation calculation method. Compared to other methods, it’s pretty accurate.
To calculate the valuation in this way, it is necessary to analyze the company’s cash flow, looking at factors such as revenues, expenses, and costs. It is also necessary to establish the discount rate, which represents the devaluation of money over time. Then, all the cash flows are added, minus the discount rates. The value is found in the company’s valuation.
2. Market multiples
The market multiples method compares the multiples of the valued business with others operating in the same market sector. A multiple is an indicator that serves as a parameter to compare different companies in the same segment. For this, you can use profit, billing, among other information.
The methodology is simpler to use, allowing for quick assessments. But it requires that the person doing the valuation knows the market in which the startup operates. Finding a similar company can also be difficult. Recent transaction data, critical to valuation, may also be unavailable.
3. Asset settlement
It is used when the partners decide to sell the company or close the activities. In this case, you need to add all the assets and subtract the liabilities.
The idea is for the buyer to be able to estimate the value he will get if he cannot keep it working and it is necessary to liquidate it.
4. Venture capital
This method starts from the investor’s point of view, evaluating the financial return that a company can bring within a certain period. The method is widely used with startups, which have great profit-generating potential.
Based on it, the investor can know how much he can earn if he withdraws the investment. It also helps investors to decide the maximum amount to be invested to achieve the desired return, within the period of their choice.
5. Scorecard
For startups that don’t have revenue yet.
To understand how to calculate the valuation of a startup with the Scorecard method, you need to know that this is an analytical and comparative valuation that uses an initial value according to the average of the market values of similar startups.
This value is following factors that you determine:
- Team capacity
- The technological innovation of the finished product
- Consumer market
- Degree of competition
For each factor, you assess the weight of your startup through a score. The result is the sum of points. Taking into account the weight of each factor, you mutltiply the number by the average value of the compared startups (with the same degree of development) at the beginning of the process. Then, you will find the valuation.
Important reasons in the business valuation negotiation
Both the investor and the entrepreneur must keep in mind:
In very high valuation startups:
- The investor may not see a sufficient return expected by him in relation to the risk he sees in this investment;
- The entrepreneur may face difficulties to make the next rounds. Investors from the previous round will expect a valuation of the Startup. It becomes expensive for the next investors and makes the negotiation difficult.
- In startups with very low valuation.
Very large dilution of the founders, which can lead to a possible lack of motivation for having little participation or even the anticipated loss of control of the company.
Beware of unrealistic assessments
In the case of startups, it’s important to be careful with unrealistic assessments. It is necessary to interpret valuations above expectations with caution.
Finally, it is worth saying that valuation is not the simplest task. The evaluation process of a company is complex, there are several methodologies available and each one has its indications and specificities.
Therefore, whether it is for the startup that wants to seek investments or for the investor, the recommendation is to research the topic, take courses and, if possible, have a specialist in company valuation during the process.
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