Startup Valuation — The Ultimate Guide to Value Startups 2020

Last Updated: 5/11/2020

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 process works is very important for any serious and committed entrepreneur.

Signup for a free webinar: Raising Capital for Your Startup: How to Raise Money for your Business Venture from Seed to Series-A

Why is it important to estimate the value of a startup?

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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 with growing the technical side of the business.

You need money for marketing, office space, prototype development, to hire staff, for 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?

Signup for a free webinar: Raising Capital for Your Startup: How to Raise Money for your Business Venture from Seed to Series-A

Which are the most popular valuation models for startups?

Venture capital firms and individual investors have dozens of models to value a startup, 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 models include:

Venture Capital Method

A startup valuation 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 Venture Capital Method’s 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 the Venture Capital Method, the Pre-Money Valuation would be:

Pre-Money = $50,000 — $10,000 = $40,000

Berkus Method

A straightforward method that values startups based on five key aspects, 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.

Signup for a free webinar: Raising Capital for Your Startup: How to Raise Money for your Business Venture from Seed to Series-A

Cost-to-Duplicate Method

This startup valuation method requires some heavy due diligence, as its main goal is to determine how much it would cost to start the same business from scratch. The cost-to-duplicate method 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)

A technical tool employed by financial analysts to determine the value of a business by estimating its future cash flows, 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 assumptions that require some historical data to be performed, it is not the most widely employed to value startups.

Comparables Method

This approach employs referential information and numbers from other similar transactions to estimate the value of a startup. 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 made some money 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 since 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

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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.

Speak with a professional to discuss your Startup Valuation at Pro Business Plans for free.

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 Venture Capital 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 including your network, your ability to draft a persuasive pitch deck and the soundness of your idea/business model. Nevertheless, you could expect to raise an amount close to the following ranges:

· 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 models are mere approximations. There’s no perfect way to value a business 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 your startup.

Pro Business Plans has been recognized as the top business plan writers by Wimgo in 2020. Visit us to learn more and schedule a free consultation.

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Pro Business Plans works with clients to prepare business plans, pitch decks, and other materials for investment and market research. | www.business-plans.com

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