This blog stems from a conversation with Brian Cashin, Senior Associate at Teamworthy Ventures. Stay tuned for our full Q&A with Brian in the coming weeks for a deeper dive on startup valuations and the current market’s impact on securing funding.
Who can say how much your startup is worth with all the complexities and variables involved? After all, most of your grand ideas are still in your head, and your company’s success lies well in the future.
Usually, the value of a company can be represented by the net present value (NPV) of future cash flows. Owners of established companies can use the NPV equation to calculate their company’s value quickly.
The net present value of future cash flows is a core valuation method. Still, it’s challenging to apply in the earliest startup stages before you can make a strong prediction of your future income and expenses.
So how will investors determine your company's value if you are just starting out?
The key to early-stage startup valuation is understanding that it’s more of an art than a science. When an investor is trying to value a business that doesn’t yet have much revenue, they must identify other business attributes where they can assign value.
The following are a few other ways investors might evaluate your startup. Use this list to help you plan and prepare everything venture capital firms might need to understand the value of your company using one of these methods.
3 Methods Of Startup Valuation
Method #1: The Berkus Method
The Berkus Method of valuation is a straightforward place to start. To use this method, investors assign half a million dollars in value to your business for every one of five non-revenue-related criteria it meets. The attributes tracked in the Berkus Method are:
1. The quality of your management team
2. Whether your business is a sound idea
3. Whether your business has a working prototype
4. Whether your business has strategic and beneficial relationships (i.e., partnerships or opportunities to acquire new customers)
5. Whether your business has made any sales
To get a quick idea of a startup’s value, investors will use this short checklist and add $500,000 for each category that is relevant to your business.
Keep in mind that some of these criteria are subjective. For example, your idea of a high-quality management team might look different from an investor’s idea.
To account for some subjectivity, it’s often a good idea to use other startup valuation methods in combination with the Berkus Method.
Method #2: The Comparable Multiples Method
With this strategy, investors will look at public companies to get an idea of how their value might compare to that of your own business.
It’s best to find a company with a similar business model in a similar industry. Look at the valuation of that company relative to its revenue. If the company matches your own fairly closely, an investor can reasonably estimate your business's future value based on this example.
Let’s say the comparable public company has a market capitalization value of $14 billion and annual recurring revenue of $1 billion. You could extrapolate that your startup, with a similar business model and industry, would have a value of about fourteen times your current revenue.
Keep in mind that you’ll never be able to find a business that perfectly matches your own. Your company, after all, should be unique enough to provide something to your customers that they can’t find anywhere else. But the Comparable Multiples Method will help investors understand if their Berkus estimation was in the right ballpark.
Method #3: The First Chicago Method Of Valuation
A group of academics at the University of Chicago first designed the First Chicago Method in the early twentieth century. The group's goal was to develop a more objective and scientific approach to valuation that would be free from the biases and subjectivity of traditional methods.
The method determines the value of a company based on its earnings power and future potential. This method is different from other valuation methods because it considers a company's current situation and future potential.
With the First Chicago Method, an investor will assign a probability to a handful of various business outcomes from least favorable to most favorable. Typically, investors assign a least optimal outcome, define one somewhere in the middle, and then decide on your best case scenario.
Investors will then assign a probability to each of those scenarios, multiply each probability by the exit value of your company in the corresponding scenario, and then take the average of those numbers. The result is the estimated valuation of your company.
See Also: How To Raise Pre-Seed Funding For Your Startup
How To Reach A Common Goal With The Valuation Of Your Startup
Three things to keep in mind when seeking a valuation.
1. Use Multiple Methods — None of these methods will render a perfect forecast, but each gives you a decent place to start. Remember, combining two or more of these methods can help you estimate more accurately.
2. High Valuations Aren’t Always Better — The goal is to find a number with which you and the investor feel comfortable. Though you might think receiving a very high valuation is optimal, it could potentially complicate things for your business in the future. Ideally, you’ll want to arrive at a value that gives your company enough credit but doesn’t set the bar so high that you’ll have trouble meeting and exceeding it in future funding rounds.
3. Build Relationships First — As you might have deduced, the investors you choose to partner with will significantly affect the valuation you receive. Every investor has a different opinion, and there’s no crystal ball for predicting the future.
If you receive a valuation you’re unhappy with, don’t be afraid to have an open and honest conversation with your potential investing partners. After all, securing funding is also heavily linked to relationship building.
See Also: How To Raise Venture Capital: Top Advice For Successful Fundraising
Lean On Zeni To Support Your Startup Valuation Process
We get it. Finding people to sit down at the table with you isn’t always easy when your company is brand new.
Zeni’s network of startup investors could become your network of investors. When you partner with Zeni, you’ll get to work with our full-service financial team members, all of whom specialize in helping startups manage their money. You’ll also have access to our groundbreaking financial dashboard and a long list of investors interested in working with startups like yours.
Plus, when you subscribe to Zeni’s CFO services, our expert team builds financial projections to show how your startup will perform against future KPIs. This could include the number of employees you’ll need to hire, expected revenues, and the rate at which the customer base will grow. In short, we give you everything you need to show off to investors.
Try out Zeni for yourself with a demo today.
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