How to Value Start-Ups

Hey Guys,

In this few Days, you must have surely heard that a start-up has become a Unicorn,

Or A start-up has raised millions of rupees in its Series C or Series-D,

At that time, I am sure you must have also thought that How a Start-up is Valued. Right?

Well, today we are going to study the same.

What all things we are going to discover in this blog: –

1. Why is Valuation Important.
2. Different Phases of Start-Ups.
3. Which Method to use in each Phase.
4. View point of Venture Capitalist.
5. View Point of Founders.

So, 1^st we are going to discuss why is Valuation so important?

Valuation determines how much ownership of a company remains with the Founder.

The Lesser the Valuation, Lesser is the ownership of the company with the Founder. Therefore, determination of the Valuation is of utmost important.

Cons of Lower Valuation:

1. Higher Ownership goes to the Investors.
2. In the next round of funding, Investor expects that they will again get higher equity of the company and this becomes the chain.

Cons of Higher Valuation:

Suppose if a company is of value 2Cr but in the market we have shown valuation of 10Cr and investors agreed to invest in that Start-Up.

But when the 2^nd Fund Raising is done, the company value has grown to suppose 8 Cr but we we have already raised money on the Valuation of 10 Cr.

So, this show a down round of a company and will have a negative impression on the company and a new reputed investor will not invest in that start-up.

Therefore, Valuation should be such that it beneficial to Founders, Investors and Company’s growth also.

Next, we are going to discuss, Different Phases of Startups: –

As all the Start-ups are not same, we can divide Startups based on Maturity.

So, based on Maturity we can divide startup into 3 phases.

• Early-Stage Start-ups
• Growth Stage Start-ups
• Late-Stage Start-ups

In Early stage Start-up, there are 4 phases

1. Idea Phase
2. Prototype Phase
3. Pre-Revenue phase
4. Early Revenue Phase

In Growth Stage Startups, Company’s product reach to huge number of customers. This happens because in this phase, company focuses a lot on its marketing and advertising. As the company product has found its market fit and its users also want to use its product. there happens an exponential growth in terms of its users, revenue, traction and valuation.

In the Late Stage startup, The company has already established its market dominance, almost everyone knows about the company, the product has also become matured. Now the company mainly focuses on its profitability.

Now with this we will also discuss, different Methods to be used in Different Phases of Start-ups:

1.Early-Stage Start-up.

As the Start-up does not have any revenue in this stage and it keeps on changing their strategies to find a product market fit, therefore we cannot use DCF method in this stage.

Investors in this stage mainly invest based on Founder and their Ideas.

Investors wants to invest in the early stage because they can invest at a very cheap rate and also if the start-up grow exponentially in the growth stage, they will get benefit the most.

In this stage we can Value the Start-up based on Transaction Comparable Method.

2.Growth-Stage Start-up.

As the company has started earning revenue in this stage therefore start-up has somewhat matured P&L and Balance Sheet.

Therefore, in this stage we can value firms based on Revenue Multiple Method or on the basis of some other operational metrics also.

For example, Few days before, A SaaS company used to get valuation of 20X that a company has a revenue of 1Cr then they used to get valued at 20 Crore.

In this stage we can use other operational metrics also to Value a Start-up

If you have a Delivery company then you can take “No. of Deliveries made” as a factor to determine the valuation

If the company is an EdTech company then we can use “Number of Students” as a Factor.

3.Late-Stage Start-up

In the Growth stage, Company mainly focuses on its Market Dominance but as company turns to a late Stage, it has already established their market and is now more focused on its Profitability.

Therefore, we can use DCF method along with Trading Multiples to value to a company.

In DCF method, we forecast the cashflow of the start-up or we can also use revenue/profitability ratio trading multiples to value a start-up.

So, this was the basic idea of how to value start-ups in different Stages. However, in the end what matters in

• How is the Idea of the Start-Ups,
• How are the market sentiments,
• Whether the Sector is Favorable or Not?

Objective of Venture Capitalist Fund

• If VCs invest in 10 Start-ups but their Expectation is that 8 out of 10 start-ups will fail. But the 2 start-ups which will grow exponentially will be able to give returns on their whole capital investments
• They mainly focus on High Growth or High Potential Start-ups who have revolutionary Idea so that they can discover them at an early stage.
• VC ideology is that whether they will get multiple returns on their investments within 3-5 years, if yes, then they can more or less consider investing in those start-up.

Objectives of Founders.

• Founders aims for the higher Valuation. As Higher valuation would be great for their ownership in the company.
• As the Start-up needs to issue shares against investor’s money, therefore higher the valuation lesser would be the need to dilute founder’s stake in the start-up.
• Normally Founders tend to raise that much capital that they require in next 15-18 months to incur their expenses for which they are ready to dilute their 15-20% equity.

I hope you got a basic Idea regarding different Valuation Techniques to use in different stages of start-up, Why Valuation is so important, Objectives and rationale of Venture Capitalist Fund and Founders.