Startups, in a very simple sense, means any new business ventures started by an entrepreneur. With mushrooming of startups, and recurring & evolving need of raising funds during different stages of growth, the valuation of startups is required quite often.
Valuation is the cornerstone of the investment process but constructing a meaningful valuation analysis can be a challenging process. Generally, the 3 most commonly accepted and widely known valuation approaches are Market-based, Cost-based and Income-based approaches, however within this a plethora of valuation framework processes exist and valuation practitioners often disagree on the best approach. This becomes even more complex especially for start-ups given the uniqueness of business models, lack of historical data & transparency, uncertainty over the future and management capabilities.
Challenges in start-ups valuation may include:
- Lacks sufficient historical financials to build or extrapolate future cash flows
- Invests in emerging assets / technology, with a risk of high failure rates, which are generally difficult to value with limited information
- Ascertaining discount rates given higher risk of failures, ability to get funding, and lack of quality information and uncertainty with respect to management capability to deliver
- Often loss-making in initial years, thereby posing challenges in applying relative valuation metrics
- Finding similar private startups and universe of comparable companies / transactions is difficult due to lack of information availability around financials & valuation
- The majority of value among start-ups is largely driven from future growth which is very challenging task to ascertain
We believe that the methodologies used to value a particular startup should be tailored & reflect upon the inherent risk, information, potential future growth and growth stage of the startup. The financing cycle / stage of a startup and associated valuation approach through which the value may be determined can be described as below:
Angel / Seed Round:
This stage is often characterized as pre-revenue, lacks viability, highly speculative and entirely depends on business idea and management capability / strength. The common valuation methodologies here may include:
- Berkus Method
- Scorecard Valuation
- Risk Factor Summation
- Venture Capital Method
Mid to late stage round: This stage is often characterized as generating / growing revenue, likely FCF negative, and capital requirement for scale-up of operations. The common valuation methodologies here may include:
- Comparables based valuation
- Discounted cash flow valuation
- Latest financing round
Notwithstanding above, there is no one-size-fits-all approach to any valuation including the startups. The Valuer has to be flexible and exercise judgement, and adopt a mix of valuation methodologies best suited for specific industry, stage and information unique to each case. At Finsurily, we triangulate various approaches after carefully analyzing the company, it’s stage & industry, dilution impact, combined with our research & analytical skills.