Startup Valuations

Startup Valuations

Valuing a Startup company is difficult. A typical valuation for a company starts with internal data revenue, cashflow and assets. With that information, you add the external data from similar or “comparables” (comps) companies. Valuation firms can then look at the data to address similar markets (vertical or geographic), size of business, cashflows and investments/exit data. Think of this like a real-estate appraisal. Without a comp, it’s hard to pick a number because your startup is standing by itself without much traditional financial data.

If you hire a valuation firm, they will look at the following three factors.

  • Asset Approach – what are the assets of the company
  • Income Approach – based on discounted cashflows
  • Market Approach – guidelines to public company data or private sales

Startups generally lack a number of those factors.

Let me also add that “wishing” for a big number won’t impact your valuation either. It’s a bit like selling a car you love, it’s worth a lot more to you than the buyer.

Why and when to do a valuation? Typically, Founders are looking for valuations at four times in the business lifecycle.

  1. Fundraising – you’re thinking about raising a round of capital and you’re looking to understand what your pre-money price should be
    1. In a fundraising round you’re looking for what the company is worth immediately before the next round of funding is deposited into the bank account.
    2. You don’t need a formal valuation for this process (or the expense of the effort), but you’ll still want to find some comps to help rationalize the price.
  2. Sales – you’re looking to sell the company and need to know if the price is fair market value (FMV)
  3. Team member exit – you have a Founder who wants to exit the company and wants to be bought out
    1. This one is hard, because no new money is coming in, but someone wants money to go out. This means that the price won’t be at a premium, but likely at a discount (cash out vs. cash in lowers the price).
  4. Annual 409A valuation plus quarterly reviews for Employee Stock Options
    1. Because of the tax implication, it’s important to know the valuation of your stock pricing for option grants.
    2. You can read a great interview here with Ben Straughan from Perkins Coie about 409A valuations.

Many factors impact the valuation, here are some things to consider:

  • If you have <6 months of cash – this likely means the price is going to go down in the upcoming weeks. Be aware that you’re likely to get ground down on price as the deal gets closer if you’re that close to running out of cash
  • State of your direct competitors – if one just raised cash or exited, your timing is likely good
  • Buyer profile:
    • Strategic buyer/investor – the strategic value will give a premium in the pricing; the goal is adding your product to their customer base, it’s the goal of 1+1=3
    • Financial buyer/investor – is going to look for a cash on cash return

The process of selling a company is like any major transaction. You have an asking price and a bid price and sometimes they are far apart. Each party wants the other to state their price first. Usually, the Startup assumes that the buyer has more insight than the seller – because they have the cash/stock to make a purchase, but that’s not really the case.

2 Replies to “Startup Valuations”

  1. Asset approach, Income approach, Market approach. This comment is about some beholders seeing more beauty than others. With the Asset Approach and Income approaches, isn’t there sometimes a positive value premium / negative risk discount from seeking funding from enterprises that invest in start ups (e.g. Intel Capital) and whose primary franchise stands to benefit directly from investing. Example: my firm assets amplify their franchise’s asset value or my firm’s solutions amplifies their firm’s income or market access.

    1. Hey Jim, great points and that is generally true for more mature stage companies. Especially when it is a “strategic” investor or buyer. The idea of strategic (info you know, but a clarifier to other readers) is that the company is already in a similar or adjacent market. Generally, they have customers that would benefit from the startup’s product.

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