Startup Valuation — The Ultimate Guide to Value Startups 2024
Last Updated: 12/17/2023
The rise of entrepreneurship has given birth to one of the most widely employed terms in the history of business and finance: ‘startups’. A startup is basically a little baby business that began with an idea and it is now looking for capital to grow and mature.
Startups, pretty much like babies, need money to expand themselves, test ideas, and develop a team. To raise money, a startup needs to be valued, and therefore, understanding how the startup valuation methods work is very important for any serious and committed entrepreneur.
Why is it important to estimate the value of a startup?
A startup can only go far when it has enough capital to fully develop its underlying idea or concept. A startup without money is destined to fail and therefore, raising capital for your startup is one of the most important tasks you may find yourself invested in, alongside growing the technical side of the business.
You need money for marketing, office space, prototype development, to hire staff, inventory, and a dozen more things and estimating the value of your startup is the only way you’ll be able to pitch your idea to an investor whose first question will be: How much does it worth? There are several startup valuation methods to choose from.
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Which are the most popular valuation methods?
Venture firms and individual investors have dozens of valuation methods, ranging from the easiest ones to the most complex ones that involve several qualitative variables and statistical analysis. Some of the most common startup valuation methods include:
Venture Capital Method
A startup valuation method often for pre revenue companies that employs a forecasted terminal value for the startup and an expected return from the investor (often stated as 10X, 8X, and so on), to determine pre-money and post-money valuations. The formula is:
Pre-Money Valuation = Post Money Valuation — Invested Capital
With the Post-Money Valuation being the terminal value divided between the expected return.
Let’s say an investor values your startup at a terminal value of $1,000,000 and he wants a 20X return on his $10,000 investment. In this case, your Post-Money valuation would be $50,000. And, according to this, the Pre-Money Valuation would be:
Pre-Money = $50,000 — $10,000 = $40,000
Berkus Method (Scorecard Method)
A straightforward method that values pre revenue startups based on five key aspects, hence the term scorecard valuation method, giving each aspect a certain amount of money
Qualitative element to be considered Value
Sound Idea
Prototype
High-Quality Management Team
Strategic Relationships
Product Rollout or Sales Made $500,000 each.
For each feature the startup possesses in full, the valuation should go up by $500,000. Nevertheless, depending on the degree in which each element is developed the investor could reduce the value of the item to say $400,000 or $250,000, to determine the final value.
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Cost to Duplicate Approach
The cost to duplicate valuation method requires some heavy due diligence, but can apply to both pre revenue and profit generating company — its main goal of the cost to duplicate approach is to determine how much it would cost to duplicate the same business from scratch including both tangible (E.g. physical assets) and intangible assets (E.g. brand value).
The cost to duplicate approach is a very realistic approach that puts into question the competitive advantages of a startup. If the cost of duplicating the startup is very low, then its value will be next to nothing. In turn, if it is costly and complex to replicate the business model, then the value of the startup will increase as the difficulty increases.
Discounted Cash Flow Model (DCF)
Valuation methods employed by financial analysts and some venture capital firms or angel investors to determine the value of a business by estimating its future cash flow, discounting them at a certain discount rate to obtain their present value.
The sum of these discounted cash flows will be the resulting valuation for the startup. Given the fact that this method relies heavily on cash flow assumptions that require some historical data to be performed, it is not the most widely employed to value startups, but is more applicable to those with historical cash flow.
Comparables Method
This approach employs referential information and numbers from other similar transactions to estimate the value of a startup. It can be used for pre revenue companies, but is more common for revenue or profit generating companies.
Let’s say that a similar app to the one developed by the startup was recently valued by a venture capital firm at $5,000,000 and the app had 100,000 active subscribers/users. This means that the company was valued at $50 per user. An investor could use this benchmark to value a startup with a similar app.
Valuation by Multiples Method
For startups that have already generated some cash flow and are showing profits, the Valuation by Multiples method is one of the most widely employed. Let’s say your startup is generating an EBITDA of $250,000.
Depending on the industry you are in, your competition, your management team, and some other qualitative aspects, an investor could tell you that he’s valuing your business at say 5X, 10X or 15X your current EBITDA. This is a powerful and simple valuation tool that investors employ to quickly estimate the value of a more mature startup.
Other popular valuation models include the Scorecard Model, the Book Value Method, and the First Chicago Method.
Picking the right method for your stage
Startups have different stages they go through from the moment the idea comes up until the point at which the company has matured to a fully-operational corporation. Each of these startup valuation models can be more useful for some stages than others and you need to determine in which stage you are in before you pick the method that is best suited for you. Here’s a list of the four common stages of startups:
Seed Stage
The earliest of the stages for any startups. At this point, there’s usually no revenue, no assets, no team, no business. Just an idea and the willingness to move forward. At this point, the Berkus Method or even the Venture Capital Valuation Method may be the most recommended for you among other startup valuation methods.
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Round A Stage
Your startup is now a solid idea on the move. You probably have a beta product or a prototype by now or you have already made some sales. At this point, you can rely on more technical methods such as the Cost-to-Duplicate method or yes, the VC Method again. Keep in mind that what you’ve done so far is not necessarily a good indication of what’s coming, so make sure you don’t undervalue your business by using current figures as if they were the ultimate performance indicator of your startup.
Round B Stage
At this point what you need is money to expand and continue growing. The business model is already proven (to some extent) by now, and your revenue-generation potential can be assessed. You can now incorporate some startup valuation models that rely heavily on financial data to come up with a number. These methods include the DCF Model and the Valuation by Multiples Model.
There are some other advanced stages that are closer to an IPO, but given the fact that getting to those stages require some major advance and advisory, you may not need this guide at that point, investment bankers and advisers will probably do a great job at valuing the business at those stages.
How much can I expect to raise on each stage?
That depends on several factors used to assess your company’s future potential, including your ability to draft a persuasive pitch deck, and the soundness the business model of your startup company.
Nevertheless, you could expect to raise an amount close to the following by estimated company value stage:
· Seed Stage: From $250,000 to $2,000,000
· Round A Stage: From $2,000,000 to $15,000,000
· Round B Stage: From $15,000,000 to $50,000,000
Bottom Line
Startup valuation methods are mere approximations compared to the more traditional discounted cash flow models and those used for an Initial Public Offering.
There’s no perfect way to value a startup company that has next to nothing. Nevertheless, the methods and details presented in this article can give you a clear idea of what you could expect and what you should be asking for by potential investors based on your startup’s valuation.
Commonly Asked Questions
Q: What traction metrics are most important for investors?
A: The answer to this depends on the company stage. For early stage companies, metrics that show product-market fit like active users, revenue growth, and retention levels are the strongest indicator. The key is to show the startup can sustainably acquire and monetize users at scale over time. As the company scales, financial metrics become more important.
Q: How much can a seed stage startup expect to raise?
A: The amount depends on the stage of the company, but seed funding rounds typically raise $500k to $2 million, though outliers happen and can go in the tens of millions. Earlier stage is typically friends and family and is more limited. Valuation expectations also range depending on factors such as team, traction, IP, and space. Most seed investors aim for 10–20% equity ownership.
Q: What milestones should founders aim for between funding rounds?
A: Between seed and Series A, important milestones should be focused on product-market fit, demonstrating efficient user acquisition methods, forming the core team, and ideally 10–20x growth in key traction and financial metrics.
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