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Startup Valuation: Top Ten Techniques

A fantastic article by Marty Zwilling on how to value your start-up.

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A fantastic article by Marty Zwilling on how to value your start-up.

1. Place a fair market value on all physical assets (asset approach)

This is the most straightforward valuation element, often called the asset approach. New businesses normally have fewer assets, but it pays to look hard and count everything you have. Sometimes founders forget to include all the computer equipment they bought or upgraded to get the business started.

2. Assign real value to intellectual property

The value of patents and trademarks is not certifiable, especially if you are only at the provisional stage. Yet the fact that you have filed is very positive, and puts you many steps ahead of others who may be stepping into the same area. A “rule of thumb” often used by investors is that each patent filed can justify $1M increase in valuation.

3. All principals and employees add value

Assign value to all paid professionals, as their skills, training, and knowledge of your business technology is very valuable. Back in the “heyday of the dot.com startups,” it was not uncommon to see a valuation incremented by $1M or every paid full-time professional programmer, engineer, or designer. Don’t forget to include the “sweat equity” for unpaid efforts of founders and executives.

4. Early customers and contracts in progress add value

Monetize the value of existing customer relationships and contracts, even contracts which haven’t yet been signed. Highlight any recurring revenues, like subscription fees, that don’t have to be sold from scratch each time.

5. Use Discounted Cash Flow (DCF) on revenue projections (income approach)

In finance, the income approach describes a method of valuing a company using the concepts of the time value of money. The discount rate typically applied to startups may vary anywhere from 30% to 60%, depending on maturity and the level of credibility you can garner for the financial estimates. For example, if NewCo is projecting revenues of $25M in five years, even with a 40% discount rate, your NPV or current valuation comes out to about $3M.

6. Multiple of discretionary earnings (earnings multiple approach)

If you are doing well, you can estimate your company’s valuation by multiplying earnings before interest, taxes, depreciation and amortization (EBITDA) by some multiple. A target multiple can be taken from industry average tables, or derived from scoring key factors of the business. If you have no better info, use 5x as the multiple.

7. Calculate replacement cost for key assets (cost approach)

The cost approach attempts to measure the net value of the business today by calculating how much it could cost for a new effort to replace key assets. If NewCo has developed 10 online tools and a fabulous web site over the past year, how much would it cost another company to create similar quality tools and web interfaces with a conventional software team? $1M might be a low estimate.

8. Find “comparables” who have received financing (market approach)

Another popular method to establish valuation for any company is to search for similar companies that have recently received funding. This is often called the market approach, and is similar to the common real estate appraisal concept that values your house for sale by comparing it to similar homes recently sold in your area.

9. Look at the size of the market, and the growth projections for your sector

The bigger the market, and the higher the growth projections are from analysts, the more your startup is worth. For this to be a premium factor for you, your target market should be at least $500 million in potential sales if the company is asset-light, and $1 billion if it requires plenty of property, plants and equipment.

10. Assess the number of direct competitors and barriers to entry

Competitive market forces also can have a large impact on what valuation this company will garner from investors. If you can show a big lead on competitors, you should claim the “first mover” advantage. In the investment community, this premium factor is called “goodwill” (also applied for a premium management team, few competitors, high barriers to entry, etc.). Goodwill can easily account for a couple of million in valuation.

 

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