12 startup valuation methods explained with clear examples

Valuation is the story of a startup's worth, potential, and place in the market. Visionary founders and savvy investors need to understand the why behind startup valuation.

In this article, we’ll explain the importance of startup valuation. We’ll also analyze popular startup valuation methods to help you choose.

Before we get to how to value a startup, let’s start with why this matters.

Why startup valuation matters

For startups, valuation is a ticket to securing funding. It's the price tag you put on your company when approaching angel investors or venture capitalists. This means a solid valuation showcases your current worth. It also shows your growth potential, providing investors with a glimpse into the returns they can expect.

Remember, a higher valuation doesn't always mean a better deal. It's about striking a balance between your fundraising goals and growth strategy.

The impact of valuation on investment

For investors, valuation is the compass guiding their investment decisions. It helps them assess the risk-reward ratio. It also helps them determine the equity stake they'll receive and forecast returns.

Valuation is like a health check-up for startups. It's a reflection of its strengths and weaknesses, informing investors if they should invest.

How startup valuation affects business planning

Valuation is a powerful tool for internal decision-making. It informs your business plan. This means it guides strategic decisions, resource allocation, and growth strategies.

By understanding your startup's value, you can set realistic goals. It helps track your progress and make informed choices about the future. Pay close attention to this, as a well-defined valuation can be the difference between a startup that thrives and one that flounders.

Equity distribution and startup valuation

Valuation plays a pivotal role in equity distribution. It aids in determining how much of the company each stakeholder owns. Whether it's founders, employees, or investors, a fair and transparent valuation ensures everyone gets their rightful share.

Keep in mind: Equity goes beyond ownership. It's about aligning incentives. It helps in fostering a shared vision and motivating everyone to work towards a common goal.

The effects of startup valuation on future growth

Startup valuation is about unlocking your company's full potential. It’s crucial to identify growth drivers, understand market position, and chart a path toward sustainable success.

A well-considered valuation becomes a strategic tool. It can empower organizations to make informed decisions, attract the right investors, and build a thriving business.

12 startup valuation methods put under the lens

We’ll now get into the central topic. Let’s dive into each one of these startup valuation methods:

1. Comparable company analysis (CCA)

This method is about comparing and leveraging the wisdom of the market. It all starts by looking at publicly traded companies similar to your startup (industry, size, growth stage).

This means you gain valuable insights into how investors value businesses with similar characteristics.

Comparing valuation metrics like the following helps you anchor your startup's valuation in real-world data:

• Price-to-earnings (P/E): This ratio compares a company's stock price to its earnings per share. It reveals how much investors are willing to pay for each dollar of earnings.
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• Price-to-sales (P/S): This ratio compares a company's market capitalization to its revenue. It shows how much investors value each dollar of sales.
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• Enterprise value-to-EBITDA (EV/EBITDA): This ratio compares a company's enterprise value to its EBITDA. To clarify, enterprise value usually refers to market cap plus debt, minus the cash value of the company. EBITDA stands for earnings before interest, taxes, depreciation, and amortization.

This valuation metric measures a company's value relative to its operational profitability.

Example: Let's say your startup is a SaaS company. You might compare it to public SaaS companies like Salesforce or Adobe. They trade at an average P/S ratio of 10x, and your startup's projected revenue is $5 million. This means a rough estimate of your valuation could be $50 million.

2. Precedent transactions

The key in this method is analyzing past acquisitions of companies similar to yours. It helps you uncover the actual prices paid for businesses in your niche. This provides a valuable benchmark for your own valuation, especially when considering the multiples from those deals.

Example: Imagine you're a fintech startup. A similar fintech company was recently acquired for $100 million and had $20 million in revenue. This means the acquisition multiple is 5x. If your projected revenue is $10 million, you might assume that your valuation is around $50 million.

3. Discounted cash flow (DCF) analysis

DCF is a powerful tool that allows you to peek into the future, albeit with a bit of financial modeling. You’re forecasting your startup's future cash flows. Then, by discounting them back to their present value, you get a sense of your company's intrinsic worth.

This is especially useful for mature startups with predictable cash flows.

Example: A biotech startup with promising drug trials might use DCF. They can estimate their present value by forecasting future cash flows from sales and applying a discount rate.

4. Berkus method

The Berkus method stands out for early-stage startups with limited financial data. It reflects that a startup's value is linked to the strength of the idea, the team's experience, and strategic relationships.

The Berkus method doesn't rely on complex financial projections or formulas. Instead, it uses a subjective, expert-driven approach. It assigns a monetary value to qualitative aspects that contribute to a startup's potential success.

Example: A pre-revenue startup with a groundbreaking idea, a stellar team, and a working prototype might receive a higher valuation under the Berkus method compared to a startup with just an idea.

5. Scorecard valuation method

Building on the Berkus method, the scorecard valuation method provides a more structured approach to assessing qualitative factors.

It involves assigning weights to different aspects like team strength, product/market fit, and market size. Then you can adjust the average pre-money valuation of similar startups to better reflect your potential.

Example: A healthcare startup with a strong team and market potential might score higher on the scorecard. This would result in a higher valuation compared to a startup with a less experienced team in a smaller market.

6. Cost-to-duplicate method

This method is grounded in the idea that a startup's value is tied to the resources required to replicate it.

It’s about estimating the cost to rebuild your business. Think technology, intellectual property, and physical assets. This means establishing a baseline valuation that's particularly relevant for startups with investments in these areas.

Example: A hardware startup is a good example for this case. The cost of patented technology and expensive manufacturing equipment will mean a higher valuation due to the high cost of duplication.

7. Risk factor summation method

This method acknowledges the inherent uncertainties of startups.

It starts with an average pre-money valuation and adjustment based on various risk factors. These factors could be management experience, competition, and regulatory risks. You then arrive at a valuation that reflects the specific risks and opportunities your startup faces.

Example: A medtech startup facing regulatory hurdles might have a lower valuation. This could happen due to the higher risk associated with the industry. Conversely, a startup with a seasoned management team might see a positive adjustment.

8. Revenue multiples

Revenue multiples offer a quick and easy way to estimate a startup's value. It’s especially useful for those with recurring revenue streams. You start by applying an industry-standard multiple to your projected revenue. The result is a ballpark figure that's often used in early-stage valuations.

Example: A SaaS startup with $1 million in annual recurring revenue and a healthy growth rate might be valued at 5-7 times its annual recurring revenue. This means the resulting valuation would be $5-7 million.

9. EBITDA multiples

EBITDA multiples are suitable for more mature startups with positive earnings. By applying an industry-standard multiple to your projected EBITDA, you assess the value based on your profitability. This is a key indicator of financial health and future potential.

Example: A profitable startup with $2 million in EBITDA and a strong market position might be valued at 10x EBITDA. This would lead to a valuation of $20 million.

10. First Chicago method

This method expands on the DCF analysis by considering three scenarios. One scenario with expected performance, one with worse-than-expected performance, and one with better-than-expected performance.

This provides a range of potential valuations. It allows for a more complete assessment of the startup's worth.

Example: A startup with high growth potential might see a wide range of valuations under the First Chicago Method. This reflects the inherent uncertainty and potential upside of its business model.

11. Book value method

This method, while simple, is often used as a baseline valuation. It calculates the startup's net worth by subtracting liabilities from assets.

The downside is it may not capture the full value of a startup, especially in its early stages. However, it can serve as a starting point for further analysis.

Example: A startup with $500,000 in assets and $100,000 in liabilities would have a book value of $400,000. This might not reflect the true value of its intellectual property or growth potential.

12. Valuation by stage

This approach assigns a range of potential valuations based on the startup's stage of development.

It recognizes that early-stage startups with just a prototype are inherently riskier. The idea is that these startups warrant lower valuations than those with proven products and established customer bases.

Example: A seed-stage startup with a promising idea might be valued between $250,000 and $500,000. Meanwhile, a Series C startup with more revenue and a clear path to profitability could be valued at $5 million or more.

What is a good valuation method?

You've got a promising startup, and you're ready to figure out its worth. But with a smorgasbord of valuation methods, which one should you choose? The short answer is, “It depends.”

Different valuation methods are best suited for different situations. The "best" method for your startup depends on several factors:

• Startup stage: Early-stage startups with little or no revenue might find the Berkus method more suitable. It focuses on qualitative factors and potential. Mature startups with established financials might lean towards DCF analysis or EBITDA multiples.
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• Industry: Tech startups might be valued using revenue multiples. Biotech startups might rely on DCF analysis due to their long development cycles. Research industry benchmarks and trends to understand what's a good valuation in your sector.
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• Market conditions: The economic climate and investor sentiment can impact valuations. A hot market with ample capital might lead to higher valuations. Conversely, a downturn could temper expectations.

Using multiple valuation methods can give you a more well-rounded picture of your startup's worth. The more perspectives you have, the more confident you can be in your diagnosis.

This means you can cross-check your results, spot outliers, and gain a deeper understanding of what’s influencing your valuation.

For example, you could start with a qualitative assessment using the Berkus method. Then, you could layer in a quantitative analysis using revenue multiples and DCF.

Next steps

You've learned about the many startup valuation methods out there. Understanding these valuation methods will paint a better picture of what investors deem a profitable venture. The common denominator is having transparent and accurate financial data that shows growth.

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