Startup valuation can be a tricky business, particularly for early-stage startups or pre-revenue companies. The question of how to value a startup is one that founders often struggle with, as it is a complex process that involves both art and science.
One way to think about “value” is to consider it beyond monetary terms. For example, a startup’s team, pipeline, and technology can all contribute to its overall value, even if it is not yet generating revenue or profits. This is known as the “art” of valuation, as it is more subjective in nature.
However, there are also more objective methods for determining startup valuation. Researching valuations for comparable companies and constructing a revenue or EBITDA multiple can provide a more scientific approach to valuation. This is known as the “science” of valuation, as it is based on data and can be more easily quantified.
When determining startup valuation, it is important to consider both the art and science of valuation. For example, a startup with a strong team, a promising pipeline, and innovative technology may be worth more than a comparable company that is lacking in these areas, even if it is generating more revenue or profits.
Additionally, it is important to consider the market size/situation and industry in which the startup operates. Startups that are operating in an industry with high valuations for similar companies may be worth more than those operating in an industry with lower valuations.
Different Methods of Startup Valuation
There are several methods that founders and investors can use to determine startup valuation. Here are ten commonly used methods:
1. Standard Earnings Multiple Method: This method is based on a multiple of a startup’s past three years average profit. The multiple typically ranges between 5 to 8x the past three years average profit (yearly) but in SAAS businesses, ranges may fall in the 8 to 12x range. This method is preferred by many investors as it provides insight into the company’s free cash flow and how it will drive incremental value to a purchaser.
2. Human Capital Plus Market Value Method: This method takes into account the value of a startup’s team and its potential market size. An investor assesses the team’s expertise and performs a mathematical valuation based on the obtainable market volume. This method is useful in assessing the potential of a startup and its future profits.
3. 5x Your Raise Method: This method is based on the amount of money a startup has raised. It is commonly used in conversations between startups and venture capitalists. The idea behind this method is that a startup’s value should be five times the amount of money it has raised.
4. Scorecard Method: This method is based on a weighted scoring system that assigns a score to various factors such as team, market, product, and traction. The scores are then used to determine the overall value of the startup.
5. First Principles Method: This method is based on the concept of reducing a complex problem to its basic elements and then building it back up. It involves breaking down a startup’s value into its individual components such as its technology, market, and team, and valuing each component separately.
6. Pre-Money Method: This method is used to determine the value of a startup before an investment is made. It involves calculating the value of the startup based on its assets, liabilities, and potential future revenue.
7. Post-Money Method: This method is used to determine the value of a startup after an investment is made. It involves calculating the value of the startup based on its assets, liabilities, and potential future revenue, taking into account the investment made.
8. Real Options Method: This method is based on the concept of a startup’s potential future options and how they affect its value. It involves valuing a startup based on the potential future opportunities it may have, such as the ability to enter new markets or develop new products.
9. Market Approach Method: This method is based on the concept of a startup’s potential market value. It involves determining a startup’s value based on the market demand for its product or service and the competition in the market.
10. Cost Approach Method: This method is based on the concept of a startup’s potential future income. It involves determining a startup’s value based on the cost of creating a similar business from scratch.
It is important to note that no single method is foolproof and it’s important to use multiple methods and consider various factors when determining startup valuation. Resources such as EU-Startups, Crunchbase, and Dealroom can also be helpful in researching comparable companies and industry valuations.
In conclusion, startup valuation is a complex process that involves both art and science. While it can be challenging for early-stage startups or pre-revenue companies to determine their worth, it is important to consider both the subjective and objective factors that contribute to a startup’s overall value. Additionally, market, technical innovation, and industry should also be taken into account.
Last but not least, also the current economic situation plays an important role when it comes to startup valuations. For example, while valuations over the past decade kept increasing (in general), since 2022 we’re seeing a clear downwards trend regarding valuations, since investors are more careful due to the economic downturn and due to the uncertainties that come with it.