Lions Financial helps Financial Institutions and Businesses, together with their tax and legal advisors, during the Due Diligence and Valuation period to make the optimal financial decisions for success. We have compiled a brief overview of What are the Methods for Valuing a Startup for Venture Capital Financing.
The issue with startup valuations is that they rely on guesswork and estimations, meaning that there is no single, universally accepted analytical methodology for investors. Instead, Venture Capitals will draw upon several venture capital valuation methods to understand the value of a startup.
The use of such valuation methods is dependent upon the stage of a business, and the corresponding data points available in the market and/or industry the startup operates in. The common methods are:
- Cost-to-Duplicate Method
- Scorecard Valuation Method
- Dave Berkus Valuation Method
- The Risk-Factor Summation Method
- Venture Capital Valuation Method
- Discounted Cash Flow method (DCF)
- Valuation by Multiples Method
This startup valuation method requires some heavy due diligence, as its main goal is to determine how much it would cost to start the same business from scratch. The cost-to-duplicate method is a very realistic approach that puts into question the competitive advantages of a startup. If the cost of duplicating the startup is extremely low, then its value will be next to nothing. In turn, if it is costly and complex to replicate the business model, then the value of the startup will increase as the difficulty increases.
The Scorecard valuation method compares the target startup company to other funded startups and modifies the average valuation. Such comparisons can only be made for companies at the same stage of development.
- Determine the average pre-money valuation for pre-revenue startups in the specific industry and location.
- Compare the target startup to the average pre-money valuation in step 1 and assign a value for each criterion.
Considering the following:
- Strength of the management team: founders? experience and skill set, founders? flexibility, and completeness of the management team.
- Size of the opportunity: market size for the company?s product or service, the timeline for increase (or generation) of revenues, and the strength of competition.
- Product or service: product/market definition and fit, the path to acceptance, and barriers to entry.
- The sales channel, stage of business, size of the investment round, need for financing, and quality of business plan and presentation.
Step 3: Calculate the percentage weights to get the total estimated value. You assign a percentage weight to each criterion based on companies? consideration and multiply it by the value you had in step 2 to get a weighted value. Then you sum up the weighted values to get the total value estimation.
You start with a pre-money valuation of zero, then assess the quality of the target company considering the following characteristics, and add up the value to get a pre-money valuation.