Startup Valuation Methods: Everything You Need to Know

What Is a Startup

A startup company is a new business that is potentially fast growing and aims to fill a hole in the marketplace by developing and offering a new and unique product, process, or service but is still overcoming problems.

Startup companies need to receive various types of funding in order to rapidly develop a business from their initial business model that they can grow and build up.

Difference Between Startup Valuation and Mature Business Valuation

Startup businesses will usually have little or no revenue or profits and are still in a stage of instability. It is likely their product, procedure, or service has reached the market yet. Because of this it can be difficult to place a valuation on the company.

With mature publicly listed businesses that receive steady revenue and earnings it is a lot easier. All you have to do is value the company as a multiple of their earnings before interest, taxes, depreciation, and amortization (EBITDA).

EBITDA

EBITDA is best shown with the following formula - EBITDA = Net Profit + Interest +Taxes + Depreciation + Amortization

For example, if a company earns $1,000,000 in revenue and production costs of $400,000 with $200,000 in operating expenses, as well as a depreciation and amortization expense of $100,000 that leaves an operating profit of $300,000. The interest expense is $50,000 leading to earnings before taxes of $250,000. With a 20 percent tax-rate the net income becomes $200,000. With EBITDA you would add the $200,000 net profit to the tax and interest to get the operating income of $300,000 and add on the depreciation and amortization expense of $100,000 giving you a company valuation of $400,000.

What determines a startup value?

Positive Factors

• Traction – One of the biggest factors of proving a valuation is to show that your company has customers. If you have 100,000 customers you have a good shot at raising $1 million.
• Reputation – If a startup owner has a track record of coming up with good ideas or running successful businesses, or the product, procedure or service already has a good reputation a startup is more likely to get a higher valuation, even if there isn't traction.
• Prototype – Any prototype that a business may have that displays the product/service will help.
• Revenues – More important to business to business startups rather than consumer startups but revenue streams like charging users will make a company easier to value.
• Supply and Demand – If there are more business owners seeking money than investors willing to invest, this could affect your business valuation. This also includes a business owner's desperation to secure an investment, and an investors willingness to pay a premium.
• Distribution Channel –Where a startup sells its product is important, if you get a good distribution channel the value of a startup will be more likely to be higher.
• Hotness of Industry –If a particular industry is booming or popular (like mobile gaming) investors are more likely to pay a premium, meaning your startup will be worth more if it falls in the right industry.

Negative Factors

• Poor Industry – If a startup is in an industry that has recently shown poor performance, or may be dying off.
• Low Margins – Some startups will be in industries, or sell products that have low-margins, making an investment less desirable.
• Competition – Some industry sectors have a lot of competition, or other business that have cornered the market. A startup that might be competing in this situation is likely to put off investors.
• Management Not Up To Scratch – If the management team of a startup has no track record or reputation, or key positions are missing.
• Product – If the product doesn't work, or has no traction and doesn't seem to be popular or a good idea.
• Desperation – If the business owner is seeking investment because they are close to running out of cash.