In today’s entrepreneurial environment, there is enormous competition among start-ups to get their companies off the ground. The ultimate goal of any new business owner is to be successful, and that starts with funding and forming partnerships with other entrepreneurs. But what happens when your start-up isn’t quite ready for investment?
Investors want to see some proof that your vision can become a reality before investing money into something that could fail miserably. This is why it’s important for start-ups or emerging businesses to carefully evaluate their company’s potential and make sure they have what it takes before they begin to seek investors.
Founders of early-stage start-ups need to understand the fair market value of the businesses they are building. Still, many entrepreneurs do miss out on how they think about valuations in an investor-friendly way. Understanding valuations and getting it right is critical for both entrepreneurs and investors. Valuations are factors used by investors to determine the future potential of a company and the likelihood that it will bring in profit.
Why is a start-up value important for investors?
Before you invest in a company, it’s important to know how to value it. Choosing the correct valuation method is crucial for your analysis. Pick the wrong one and you could be left with a false impression. A valuation is a business appraisal that is used to have an objective and unbiased opinion of the company’s potential.
How to Value a Company and build your portfolio?
Developing an investment thesis is a key part of the equity valuation process. It requires finding data and analyzing the potential pitfalls and pros of your proposed investment. Valuing a business requires that you strike the right balance between being too conservative and being overly aggressive.
How To Value Your Business?
Valuation is an art and science, with multiple methods in toe like the start-up type, stages of development, investor types and various other factors. In short, valuation is about weighing one’s expectations with the tangible numbers that we derive from the business.
There are two ways to determine the valuation of an early-stage company. The first includes direct comparison. This method compares similar companies that have been acquired in the past and uses them as a reference for establishing a probable value for related entities. This approach considers the fact that each entity is unique and has its own value. Still, it’s important to consider that there are cases when there aren’t many or any similar companies or if a company has been acquired very recently, causing their valuations to be irrelevant.
In the other, besides the direct reference, various other factors like the sustainability of founders, capitalization and dilution of investment, use of equity as a competitive performance evaluation, and so much more will also be calculated. To calculate the value of an early-stage start-up, you must consider various factors such as market, customers, funding, and team. Let’s get into the nitty-gritty on how to actually calculate your business’s value.
Berkus Method – This is one of the simplest methods used by many early-stage investors as well as first-time investors. In this method, a specific band of value is allocated to –
- Idea (basic value, product risk)
- Prototype (reducing technology risk)
- Quality Management Team (reducing execution risk)
- Strategic relationships (reducing market risk and competitive risk)
- Product Rollout or Sales (reducing financial or production risk)
After a value is assigned, an aggregate of this value is defined as a derived valuation of the business.
Bill Payne Method: A scientific scorecard-based mechanism with a distributed weightage and rating-based valuation method. In this, the business is rated on the following parameters.
- Strength of Entrepreneur and Team
- Size of the Opportunity
- Product/Technology
- Competitive Environment
- Marketing/Sales/Partnerships
- Need for Additional Investment
Each of these parameters will conclude a score after applying the weight and rating. This score then becomes the multiplying factor over the average pre-money valuation.
Besides the above methods, there are proprietary scorecard methods like StartupBay Scorecard etc., which are customized with more data on specific sectors, markets, and technologies. When you’re ready to take your company to the next level, it’s important that you have a realistic and reasonable appraisal of its current value. When making decisions about your company’s valuation, management needs to understand the right method to use.
A dollar in equity is not equal to a dollar at a financial institution. The time value of money represents how every dollar invested over a certain period of time will be worth more than a dollar today.
– Amit Jain, Managing Partner, StartupBay
About the Author
Amit Jain comes with a lineage of building successful technology businesses both as a top industry executive and as a serial entrepreneur. He is known for his in-depth understanding of the subject and has a flair to visualize and model the new.
A believer in the power of the collective, Amit started StartupBay in 2016, an initiative focused on founder coaching on the entire nine yards to become a successful entrepreneur. Over the past six years, Startupbay has helped more than 1000 founders deeply understand various aspects of building successful companies.
About StartupBay
StartupBay is a start-up enabler with resources and partners across technology and business domains to help start-ups succeed. A culmination of talent from technology, financial management, business management, behavioural science, human resources, digital marketing, among others, caters to start-ups’ constant hunger for rapid growth throughout the accelerator program.
