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Tag: startup valuation

  • Why Do Startups With the Highest Valuations Make the Least Profit?

    Just because of valuation, startups often take the limelight as unicorns even when they are losing hefty amounts of money. This may seem strange, but older businesses are not regarded as strongly as startups, and in most cases, these existing businesses are valued well below their genuine value.

    Every day, businesses of every kind face an unpredicted plethora of threats. It is important to recognize that losses can be either caused by temporary (short-term or medium-term) or some continuous long-term issues.

    Number of Funding Deals for Startups Across India from 2015 to 2022
    Number of Funding Deals for Startups Across India from 2015 to 2022

    Unicorns in India, or companies valued at $1 billion or more, are contradicting the traditional wisdom that valuations are based on future earnings. As their losses mount, private investors are compensating them with progressively greater values.
    While lots of businesses continue to lose money quarter after quarter, a select handful achieves enormous success and become national brands. The trick, of course, is determining which of these businesses will make the transition to profitability and blue-chip position.

    Valuing a loss-making business can be a difficult task. A business with negative earnings or incredibly low earnings is considerably more difficult to appraise than one with positive earnings. In reality, rather than basic assessments, loss-making enterprises are valued primarily on hopes.

    In this article, we are going to discuss why we see that startups with the most valuation have the least profit.

    Startup Valuation
    Why High Valued Startups Have the Least Profit?
    Cases of High Valuation Low-Profit Startups

    Startup Valuation

    In simple words, startup valuation is the way of assessing a firm’s value, or valuation. An individual investor in a startup trades for a portion of the company’s stock during the seed fundraising round. This is why valuation is crucial for entrepreneurs since it allows them to determine how much ownership they must provide a seed investor in return for their financing. It’s also crucial for an investor, who needs to know how much of the company’s stock they will get in exchange for the money they put in during the early stages. As a result, startup valuation can be a deal-maker or a deal-breaker, which is why it does not include any speculation based on the valuation of other comparable businesses.

    Furthermore, before assessing a firm’s real worth, creators must have a thorough understanding of how the entire startup valuation process works. If there is little to no revenue-generating, founders tend to quote an excessively high amount to investors to raise seed funding, so the expectations will be rather high. However, if a firm is unable to fulfill the lofty targets, it may have to secure funding at a reduced valuation in the next round.

    This could backfire in the long term, and the startup or entrepreneur may have a difficult time persuading other seed financiers or companies to finance them. In contrast, if the business quotes are too low, it may wind up offering investors a larger portion of the company’s equity, which will be a negative factor.

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    Why High Valued Startups Have the Least Profit?

    Startups are not anxious about their losses or lack of profit-making capacity. Instead of focusing on this, they continue to advertise their long-term vision of expected profit generation. Founders of such startups tend to showcase their different techniques, technologies, and solutions to attract investors. They are good at storytelling and selling.

    Investors get inspired by the founders and their exclusive pitch and make startup investment risks with the hope of gaining profits in the future. Here, both the startups and the investors work based on future assumptions. The hope remains on the fact that the startup would be able to kill its competition and create its market. But when reality hits and things do not go as per the plans, these startups with high valuations (because of the huge investments) start going low on profit-making.

    It is the brand name and its worth that attracts investors to invest, taking the valuation of a startup to another level. For example- Groww (an investing platform), even with the least profits, raised a funding round in October 2021, which skyrocketed its valuation to $3 billion. However, Zerodha (financial services company), one of its biggest competitors, is highly profitable yet its valuation stands lower than Groww.

    According to Kunal Shah (CEO of CRED), “Unicorn tag, high valuation are all vanity metrics till the company delivers profits”.

    The discounted cash flow is the explanation for this unusual valuation. The discounted cash technique is used to value and evaluate the worth of the startups. When valuing a company, the discounted cash flow technique is used to forecast cash flow as well as the anticipated rate of return on investment. Businesses that are inevitably destined to fail in terms of income flow generation are given a higher discount rate.

    Such startups simply continue to be overvalued by executing a couple more spectacular funding rounds. After which the investors understand or anticipate that they’re not going to be successful after analyzing the stats and other relevant information and pulling any additional funding. These businesses will likely close or downsize their operations, leading to widespread job losses and a repeat of the 2008 financial crisis unless they figure up some sort of magical formula.

    Cases of High Valuation Low-Profit Startups

    Zomato

    The revenue of Zomato has soared by a significant percentage year over year, and losses have also risen by a substantial proportion. However, when you look at the overall picture, Zomato is present in 24 countries, including India. Furthermore, it has a monopoly in Restaurant Search in India, despite the presence of competitors making it more likely to succeed. Advertisements, classifieds, internet shopping, and consulting are further sources of its revenue.

    Revenue and Loss of Zomato from FY 2018 to FY 2022
    Revenue and Loss of Zomato from FY 2018 to FY 2022

    In FY22, Zomato recorded a revenue of $505.76 million, whereas its loss stood at $145.92 million. As a result, instead of seeing losses as a determining factor in funding, we perceive its brand value.

    Flipkart

    Although this is one of the most difficult startups to evaluate, the basics stay the same. Flipkart is attempting to instill in Indians the habit of shopping online. This is also being funded by investors. Online retail sales in India currently account for only 1% of total retail sales. If it were to rise to even 7-8% (as it is in the United States), E-tailer revenues in India would soar by a significant percentage. This is the expectation of investors.

    In FY22, Flipkart India’s revenue reached $6.034 billion, and losses widened by 40% to $410.75 million.

    Ola/Uber

    We usually went down, asked for multiple buses and taxis, and got refused by a majority of them when there was no Ola/Uber. But, thanks to Ola, we can now book a cab from the comfort of our own homes or offices and only get out when they arrive. It has made our lives more convenient with the added benefits of being cashless and air-conditioned. As a result, we have developed a strong trust and habit in them, which is exactly what they desire.

    Revenue and Loss of Ola Cabs from FY 2017 to FY 2021
    Revenue and Loss of Ola Cabs from FY 2017 to FY 2021

    In FY21, Ola Cabs’s revenue was $125.41 million, and its loss was $101.27 million.

    These are some of the names that stand in full pride with huge valuations as they have gained the trust of investors as well as the masses but at the same time continue to make lesser profits.

    Conclusion

    A startup’s worth is based on its potential to generate future cash flows, how much potential it has for future aspects, and keeping other essential factors constant. Apart from revenue generation, job generation statistics also matter. Investors believe that the startup they are investing in will grow to be a giant one day and that they will be able to make a profit of nearly ten times their initial investment. This risk allows them to stay competitive and keeps them in the play. Therefore, when valuing or comprehending startups, their prospects are perceived rather than the losses.

    FAQs

    What is startup valuation?

    It is the process of evaluating a company’s worth in the market based on different factors like profit-making capacity, growth potential, market conditions, etc.

    What are startup valuation methods?

    Popular methods include:

    • Berkus Approach
    • Market Multiple Approach
    • Risk Factor Summation Approach

    Which is the highest-valued company in India in 2022?

    Reliance Industries is the highest-valued company in India in 2022 with a $202 billion valuation, followed by Tata Consultancy Services ($139 Bn) and HDFC Bank ($97 Bn).

    Are all Indian unicorn startups profitable?

    Only 23 out of 100 Indian unicorn startups are profitable. These include Mamaearth, Lenskart, Nykaa, Zerodha, etc.

  • What caused Klarna’s valuation to drop from $45 billion to $15 billion

    Klarna, a European buy-now-pay-later (BNPL) service provider, is raising investments at a valuation of $15 billion. There was a dramatic decline in their mid-2021 $45 billion valuations and the estimated 2022 $30 billion figure. In recent quarters, not just Klarna, many fintech companies have fallen sharply.

    Klarna is the second-largest BNPL service provider. It allows interest-free finance to consumers. These services have gained popularity, especially after the COVID-19 pandemic.

    The latest investments in Klarna were led by SoftBank’s Vision Fund 2. They cement its status as one of the finest fintech startups by valuation. However, this market is deteriorating at a rapid rate and the best-known private fintech company is caught in the mix. Here’s why Klarna’s valuation dropped from $45 billion to $15 billion in 2022.

    What is Klarna?
    Klarna Valuation to Drop From $45 Billion to $15 Billion
    Why Is Klarna’s Valuation Declining?
    The Situation of Klarna in 2022
    Investments & Backers of Klarna in 2022

    What is Klarna?

    Klarna is a Sweden-based fintech company. It was established in 2005 in Stockholm. Niklas Adalberth, Sebastian Siemiatkowskiand Victor Jacobsson are the co-founders. Their sole purpose is to make online shopping effortless for consumers.

    Klarna, also known as Klarna Bank AB, offers numerous online financial services. These include direct payments, online storefronts or BNPL services. Since 2005, Klarna has been on a mission to make payment as simple, safe, and smooth as possible.

    After serving the world for over 17 years, Klarna is now the world’s leading global payments and shopping service. Today, it holds almost 147 million users with more than 400,000 merchants across 45 different countries.

    Klarna Valuation to Drop From $45 Billion to $15 Billion

    The Swedish fintech company is seeking to raise funds at almost three times less valuation. Last time the company closed the round at a valuation of $46 billion with SoftBank, becoming the world’s second valued startup. However, on Friday Wall Street Journal reported that the valuation shrank to $15 billion while raising $500 million from investors. The journal reported that last month Klarna had pitched a proposal of $30 billion to the investors, which now closed at $15 billion.

    Valuation History of Klarna
    Valuation History of Klarna

    Why Is Klarna’s Valuation Declining?

    Last month, the Journal reported that Klarna’s CEO Sebastian Siemiatkowski made public the company’s situation. Citing market constraints, he announced that the company was laying off 10% of its international workforce.

    Through a pre-recorded video message, he said, “We are strongly influenced by the outside world. When we set our goals for 2022 in the autumn, it was a very different world than the one we have today. What we are seeing now in the world is not temporary or short-lived, and hence we need to act.”

    In the same week, Sifted reported that the company’s pre-tax losses have tripled to $250 million in the first three months. BNPL startups, such as Klarna, survive a low-interest-rate environment. Merchant fees and late payment charges bring enough revenue but the margins have been narrowing, as of now.

    The company’s CEO also spoke about how users are gravitating towards debit and rejecting interest-and-fee-laden credit. He said, “Consumers continue to reject interest-and fee-laden revolving credit and are moving toward debit while simultaneously seeking retail experiences that better meet their needs,”

    “More transparent and convenient alternatives align with evolving global consumer preferences and drive worldwide growth,” he added.

    The Situation of Klarna in 2022

    Starting in 2022, when Klarna submitted its first-quarter report, it was noted that 10% of the staff were terminated. However, speaking over the report, the company said that “still seeing strong growth across the business”, it was “time to consolidate and capitalize on strong foundations”.

    Now, looking at the huge financial loss, it seemed that this was the reason why the company decided to cut costs.

    As per the report, Klarna’s last fundraise was way lower than the previously raised value. They planned to raise a total of 1 billion dollars with a valuation of 30 billion dollars. However, the board conference didn’t go well and they had to adjust with a valuation of 15 billion dollars.

    Thereby in an attempt to cover the losses, Klarna’s CEO in early June declared that it would terminate its global employees. As a result, approximately 700 employees would lose their jobs.

    Investments & Backers of Klarna in 2022

    Swedish battery maker Northvolt raised $2.75 billion in a round valuing the company at $11.75 billion. According to Pitchbook, 2021 set a record for European tech startups raising $52B. As of June 22, European startups have already raised $45 billion.

    “The international money is coming into Europe,” Hans Otterling, general partner at Northzone and an early investor in Klarna, told CNBC. “For Silicon Valley, the talent pool has been depleting for some time. We have a huge talent pool in Europe.” Klarna’s other backers include the likes of Chinese fintech giant Ant Group and U.S. rappers Snoop Dogg and ASAP Rocky.

    Last month, Klarna was hit with a data breach. Consumers reported that they were being logged into others’ accounts. This caused the company to officially shut down their app.

    They addressed the issue later through a blog post. They stated the bug was caused by “human error” and that it had “informed appropriate authorities.” However, this affected more than 9500 Klarna consumers.

    Almost 73% of all e-commerce exchange transactions drove through Klarna. Due to the everlasting customer acquisition, the company claims to hold a valuation of a total of $45.6 billion in 2021. It is seconded by investors across the world. Some of them are Silver Lake, Dragoneer, Permira, Atomico, Sequoia Capital, Ant Group, Bestseller Group and Visa.

    FAQs

    What is the valuation of Klarna?

    The valuation of Klarna is $45.6 billion but is predicted to drop down to $15 billion.

    Who founded Klarna?

    Sebastian Siemiatkowski and Niklas Adalberth founded Klarna in 2005.

    What is the revenue of Klarna?

    The revenue of Klarna was $1.42 billion as of 2021.

  • How to Evaluate the True Worth of an ECommerce Business?

    Running an eCommerce business has emerged as a highly lucrative and sought-after online business model. It allows you to expand your customer base on a global level without requiring massive investment. If you know all the ins and outs of running a successful eCommerce store, you can rake millions in revenue in an incredibly shorter timeframe. But this is just one way to earn using eCommerce stores.

    Another way is to sell it off for a rewarding price. If you take a quick look at different website flipping marketplaces like Flippa, Empire Flippers, etc., you will find various eCommerce stores listed for sale. The listing price is usually a multiple of the revenue the site generates. If you don’t want the hassle of maintaining multiple stores, you can choose to set up profit-generating eCommerce stores and start selling them for substantial profits.

    But the question is, how will you know the ideal selling price of an eCommerce store? You can do it by evaluating the store’s worth using the following methods.

    Ways to Evaluate the Worth of an eCommerce Store

    Valuation Factors that Matter for ECommerce

    Determine the True Value of an eCommerce Store for Maximum Profits

    Ecommerce Business Valuation

    Ways to Evaluate the Worth of an eCommerce Store

    There are various methods to evaluate the worth of an eCommerce store, but specific methods are best suited for particular situations. You can use any of the techniques shared below that you deem fit.

    Seller Discretionary Earnings

    When evaluating an eCommerce store’s worth, factoring in the seller’s discretionary earnings emerges as the top option. It can be best described as net earnings before tax. To get the most accurate figure, you will have to deduct the total cost of products sold and operating expenses from the sales revenue and then multiply it by a given number. This number ranges from 1.5 to 5 and depends on various factors we will cover later in this guide.

    After deducting these expenses, you can add back any costs that are not deemed mandatory to operate the store smoothly. The owner’s earnings can also be added to gain better clarity on the total revenue. In simple words, the net profit of the past months (generally 12 months) is taken into account and then multiplied by a number (ranging from 1.5 to 5) to ascertain the store’s present worth.

    Discounted Cash Flow Analysis

    Buyers that want to estimate the future return on investment after factoring in inflation should use this method to evaluate an eCommerce store’s worth. Although it is best suited to calculate the worth of traditional, offline stores that are more stable, one can always turn to this option for analyzing an online store’s value more reliably.

    Under this method, you must deduct the last year’s capital expenditures from the operating cash flow. The resultant figure will be the free cash flow for the particular period. Do it for the previous five years to get an accurate cash flow growth rate and discount it according to the WACC of the eCommerce business.

    For the uninitiated, WACC refers to the Weighted Average Cost of Capital. If this looks too technical, it is best to hire a professional to do it for you. If the current Discount Cash Flow (DCF) remains above the proposed investment figure, the investment could result in positive returns in the near future.

    Precedent Sales

    It cannot be termed the primary value evaluation method, but it can help the eCommerce store buyer and seller arrive at figures worth contemplating. If the previous two methodologies weren’t sufficient, try looking at the listed selling price of similar eCommerce stores on online marketplaces.

    The acquisition price of similar eCommerce stores can offer some insightful points for reference. It can get tricky as the valuation criteria are never the same for all stores. Hence before proceeding with this point, predetermine a few key metrics, like company size, annual revenue, years of operation, and other things that are relevant to you.

    Both buyers and sellers can have an unreasonable figure in mind, and checking the precedent sales can give a reality check to both.

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    Valuation Factors that Matter for ECommerce

    Valuation of e-commerce industry
    Valuation of e-commerce industry

    Now that you’re aware of the standard and most popular methods to determine the worth of an eCommerce store, let’s quickly get a brief understanding of the factors that play a crucial role in most valuation processes.

    Store Traffic

    ECommerce Websites Traffic
    ECommerce Websites Traffic

    All eCommerce stores rely significantly on online traffic because higher traffic often translates to higher sales and vice-versa. Besides the quantity, it is also the quality that matters. For example, an eCommerce store attracting 5,000 high-quality monthly visitors will be worth much more than a store that attracts 50,000 low-quality monthly visitors.

    Customer Base

    Customers are the lifeline of any business, and eCommerce stores are no different. If your eCommerce store has a dedicated and loyal customer base that makes repeat purchases, its value will always be on the higher side. Many sellers make it a point to check the statistics related to repeat purchases before making any purchase decision.

    Brand Value

    If given an option, would you buy a product from a well-known brand you trust or a new store? You’ll most probably go with the former option because you’ve imposed your trust on the brand. Other online shoppers also think along the same lines. The sales prospects of a branded eCommerce store will always be higher than that of a non-branded one. Hence, you should never ignore this factor while determining the store valuation.

    Besides these factors, you can also consider the financial history and operating costs for a more appropriate valuation.

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    Determine the True Value of an eCommerce Store for Maximum Profits

    Evaluating an eCommerce store’s worth isn’t easy and requires much of your time. But putting your efforts into it can prevent you from underselling your eCommerce store or paying more while buying one. If you want to employ the correct business valuation methods, you can stick to the above mentioned options. These methods are used by a major portion of eCommerce store buyers and sellers, so you have nothing to worry about.

    FAQs

    What are the types of e-commerce stores?

    Traditional types of eCommerce stores are:

    • B2C (Business-to-Consumer)
    • B2B (Business-to-Business)
    • C2B (Consumer-to-Business)
    • C2C (Consumer-to-Consumer)

    What are different ways to evaluate the worth of an eCommerce store?

    The Worth of an eCommerce Store can be evaluated by:

    • Seller Discretionary Earnings
    • Discounted Cash Flow Analysis
    • Precedent Sales

    What are the factors for ECommerce Valuation?

    Valuation Factors that Matter for ECommerce are:

    • Store Traffic
    • Customer Base
    • Brand Value

    What are the marketplaces for eCommerce stores sale?

    Some marketplace where ECommerce stores are listed for sales are:

    • Flippa
    • Empire Flippers
    • Motion Invest
    • MicroAcquire Marketplace
    • Investors.Club

    What is the biggest ECommerce store?

    Amazon is the biggest ECommerce store.

  • How to Calculate Valuation of Your Startup?

    In the competitive entrepreneurship world today, entrepreneurs are quite excited about adding value to their startups. It is one of the most essential things to do for founders as it helps in further equity and funding decisions. Quantifying the worth of a startup is the most complex task to do. There are several methodologies and approaches to determine the valuation of your startup. The worth of a startup depends on several factors:

    • The business idea of the Startup
    • Stage of the startup
    • Product Prototype
    • Market risks and competition
    • Technical Adaptability
    • Customer traction
    • Investors

    Let’s know about the approaches used by startup founders and entrepreneurs on how to calculate the valuation of your startup.

    Mehul Sharma – Founder & CEO, Signum Hotels & Resorts

    Mehul Sharma - Founder & CEO, Signum Hotels & Resorts
    Mehul Sharma – Founder & CEO, Signum Hotels & Resorts

    Pre-revenue start-up valuation may be a complicated endeavour. There are many factors to take into consideration, from the control group and marketplace traits to the call for the product and the advertising dangers involved. And a hard truth associated is that even after comparing everything, despite the only pre-revenue valuation formula, the first level you may get continues to be simply an ESTIMATE!

    The world of the start-up is a place full of enthusiasts. A start-up is initiated every 3 seconds around the world! Every big company you can think of started from a garage with a computer bought with savings money or some sort of gift. But not all start-ups share the same start.

    Business proprietors will wish for an excessive valuation, while pre-revenue investors might opt for a lower price that guarantees a larger go back on investment (ROI).

    So, how does pre-revenue start-up valuation evaluate with a mature commercial enterprise valuation?

    Unlike early-stage start-ups, a mature publicly-indexed commercial enterprise will have extra information and figures to head on. Regular circulation of sales and monetary statistics make it less difficult to calculate the price of the commercial enterprise. More often than not, early-stage startups are valued somewhere within the middle, which means founders don’t get quite the amount they anticipated, and investors pay higher than what they intended to invest.

    For most start-ups especially pre-revenue, Traction is one of the significant indicators for assessing the worth. The true story of a start-up can be brought into the daylight by taking a look at its effectiveness in the market, the number of users, and its growth rate.

    Estimating the actual worth of an unlisted startup before the seed funding is actually of equal importance to having a business idea while going in.

    There are various ways to estimate the current worth of a business, but only a few are used as a daily pill by entrepreneurs.

    The most basic method to assess the value is by analyzing the previous year’s Balance sheet. Under this method, the total debt and liabilities are subtracted from the aggregate value of assets owned by the business. This method is less complicated, easy to assess, and comes in handy.

    Although, the Balance sheet method does not provide the whole picture of the situation. The problem here is that this methodology considers the start-up in its current state and not how it’ll be in the future. Investors are inquisitive about the latter, and so, as an asset-based valuation doesn’t take that into account, this method has its drawbacks.

    Another method of assessing the valuation of a business is by calculating the EPS (Earnings Per Share). EPS is calculated by subtracting the Preferred dividends from the Net income and further dividing it by the average of outstanding common shares. For an individual investor, EPS shows the exact value of revenues and makes more sense.

    The valuation of a start-up is a complex task and there is no straight jacket solution or method to be put into use each time. Often, the valuation is calculated using a combination of ratios, and ordinal values.

    The angel capitalist Dave Berkus believes investors ought to be ready to envision the corporate breaking of $20M in 5 years. His technique assesses five important aspects of a start-up, namely, Concept, Prototype, Quality Management, Connections, and Launch plan. The Berkus technique is an easy estimation, typically used for IT start-ups. It is a good way to gauge value, however, because the market into account isn’t taken into account, it’s not going to provide the scope that some folks desire.

    Furthermore, a few more methods like EDITBA (Earnings before interest, taxes, depreciation, and amortization), top-line method, and GMV (Gross Merchandise Value) have been proven to provide significance for the estimations.

    EDITBA is another easy-to-use method that provides ordinal values by using the previous financial statements. Varied business segments face varied rates of tax payment based on the industry they fall into.  A business with a higher revenue may have an NPV (Net Present Value) lower than the one with lesser revenues due to the different industries they fall into.

    Another interesting method for assessing the value is the Top Line method, which is a reference to gross figures reported by a company, such as sales or revenue. This method gets the name because these are shown at the top of a company’s income statement and are kept aside for the reporting of revenue and or gross sales.

    GMV method ascertains the gross value of sales in the market. Under this, the gross value of the merchandise is calculated as the Sales price of goods with the number of goods sold. It shall be noticed that GMV is calculated in conjunction with net sales, which takes deductions into account.

    The first-time valuation of a start-up is bound to foresee at least a few mistakes. Hence, while evaluating the value of your start-up two big pitfalls one shall avoid are:

    1. Never assume a valuation is Permanent, i.e., after all, a startup is going to be valued at what investors are willing to speculate in it. Ultimately, it shall be kept in mind that the variables are at play, and perceive that no valuation, high or low, is ever permanent- or maybe even correct with certainty.

    2. A Valuation is never straightforward, i.e., even after getting a pre-revenue start-up valuation you’re happy with, it’s best to debate things in nice detail with potential investors simply to ascertain that everyone is on the same page regarding the way to proceed.

    It is rightly said that only a fool would make peace with the first valuation he gets of his business as there are complexities and human factors involved.

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    Vicky Jain – Founder, uKnowva

    Vicky Jain - Founder, uKnowva
    Vicky Jain – Founder, uKnowva

    Startup valuation is not an exact science. Factors can include the industry, the present market, the team’s credentials, and other forces that might be taken into account. The valuation of a start-up is the measure of how much investors think the company is worth right now. One of the simplest ways to measure the value of a startup is with the scorecard method. By weighing up parameters of success like team experience, competition, the strength of the product, etc.) subjectively, this method enables comparisons between a startup and other “average” startups within the industry and area. If the startup looks to have more than average qualities as per the calculations, then the chances of getting a higher valuation increases and so does the investment opportunity. There is another method known as the discounted cash flow method that approximates how much flow of cash a startup will produce over a long period of the term. By predicting this and calculating the expected return on the rate of investment, assumptions can be made about a start-up’s value.

    Sharan Goyal – Founder and Director, Crozzo

    Sharan Goyal - Founder and Director, Crozzo
    Sharan Goyal – Founder and Director, Crozzo

    Valuation in today’s day and age has taken a very sinister meaning. Valuations are through the roof, with no stopping in sight. I prefer to find a reasonable multiple of EBITDA or revenue (in the case of a cash flow negative company) and compare that to that of an existing business which has raised funds at a particular multiple. For example, a D2C business in the food space with a solid distribution network is often valued at 15-20 times forward revenue. It would be fair to assume that a company with a similar profile can be valued at a similar multiple.

  • What Is Startup Valuation? Methods Of Startup Valuation

    Startup valuation is both art and science combined. The gut, instinct, and gut instincts are usually involved. Well established companies are easier to value because you can throw their revenue in a spreadsheet and work its magic. They have numbers. A startup in its initial state lacks solid numbers. Only forecasted values are available, and those are just an estimation.

    Why is valuing a startup necessary, you might ask. Valuing helps an investor decide if the startup is worth investing in. And why are startups valued so high? Showing a high and solid valuation attracts investors like bees to honey. The valuation also helps entrepreneurs in determining how much of a share to give to investors in exchange for their money.

    But having a high valuation at the start is not compulsory. It just means that a high valuation at the seed round implies higher valuation in the next round. For that, you will need to show considerable growth. A general metric is showing 10x growth over eighteen months. There are two strategies regarding valuations:

    • Go big or go home – Raise a large amount at the highest valuation and grow as fast as possible. If successful, the seed round will fund itself. And the dilution rate is less as compared to a slow-growing startup.
    • Slow and steady – This involves a steady growth rate where you raise only as much as you need and spend as little as possible.

    Factors That Impact Startup Valuation

    Industry

    If the industry is booming, investors are more likely to sink money into your venture.

    Customer base

    Showing that your company has customers is a surefire way of showing high valuation.

    Reputation

    If the owner has a stellar record of running businesses or the product/service is a successful one, investors are more likely to get attracted even if the business lacks a customer base.

    Supply & Demand

    If the demand is high, a high valuation can be placed. If the supply is higher than demand, investors might be less willing to invest a large amount.

    Product

    Lack of need for the product or if the product is not of good value, the valuation of the business is lowered.

    Competition

    The business will find it difficult to carve a niche for itself if there is no scope left, i.e if there is heavy competition.

    Management

    Sometimes, an outstanding team is enough to inspire confidence in an investor. Lacking that can make things go downhill.

    Pre-evaluation revenues

    This depends on whether you already have a commercial product/service in hand and if it is generating any revenue. An existing revenue is a positive cause for convincing an investor.

    Methods of Valuation of Startups

    Cost-To-Duplicate

    In this method, the hard assets are taken into account and the cost of duplicating the same business elsewhere is estimated. Unfortunately, this method does not take into consideration the growth potential and intangible assets such as brand value, industry trends, or reputation. This method gives us the ‘lowball’ estimate of the venture.

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    Discounted Cash Flow

    This method determines the cash flows generated in the future and sets and applies a discount rate to the value to arrive at the probable valuation. The cash flow determination depends on market fluctuations and the ability of the analyst to make good assumptions. The discount rate is proportional to the risk factor.

    What is Startup Valuation
    Discounted Cash Flow

    Berkus Method

    This is the most popular method in use. It is used for the valuation of pre-revenue startups. This is how it works :

    If It Exists Add Company Value Upto
    A Sound idea $ 0.5 million
    Prototype or working model $ 0.5 million
    Quality management team/ Reputed leader $ 0.5 million
    Strategic relationships/ Partnerships with industry $ 0.5 million
    Product rollout or sales (initial revenue) $ 0.5 million

    Comparables/Multiples Method

    This method works on the principle ‘one price for all’, meaning similar companies are worth the same.  Essentially, similar startups are compared. It uses industry ratios such as price-to-earnings ratio, price-to-sales ratio, values-to-earning before interest, etc., It also takes factors that are not similar for both companies into account.

    What is Startup Valuation
    Comparable Company Analysis

    Image Source: CFI

    One disadvantage of this method is that there is a slim chance of finding similar startups as business ideas tend to be unique.

    Scorecard Valuation Method

    The average pre-money valuation of all startup businesses in the area is determined. The startup in question is valued against them on the basis of a scorecard. The Scorecard consists of the following factors and their weightage.

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    Risk Factor Summation Method

    This method uses the same average pre-money valuation method and compares twelve elements of a target startup to a funded and profitable startup. The elements are as follows:

    • Management
    • Stage of the business
    • Legislation/Political risk
    • Manufacturing risk
    • Sales and marketing risk
    • Funding/capital raising risk
    • Competition risk
    • Technology risk
    • Litigation risk
    • International risk
    • Reputation risk
    • Potential lucrative exit

    Each parameter is awarded a value ranging from +2 to -2, with +2 being a positive valuation of the company for that parameter and -2 being negative.

    Valuation By Stage Method

    This method is similar to the Berkus method but treats the parameters in the latter as subsequent stages. Generally, the stages appear to be:

    • ‘An exciting business plan’ -may warrant around half a million
    • ‘A strong management team’ – may warrant one million
    • ‘Availability of prototype or finished product’- may warrant around 1-2 million
    • ‘Partnerships or steady customer base’- may warrant around 2-5 million
    • ‘Shows signs of growth and profitability’- may warrant greater than 5 million

    The amount is the valuation of the company and gives an idea of how much an investor might be willing to invest in your startup.

    Venture Capital Method

    Professor Bill Sahlman of Harvard business school introduced this method. The following formulae are used:

    • Return on Investment (ROI) = Terminal (or Harvest) Value ÷ Post-money Valuation
    • Post-money Valuation = Terminal Value ÷ Anticipated ROI

    This method is meant for pre- as well as post-revenue startups.

    First Chicago Method

    This method is a very qualitative way of determining the state of the startup. Three different evaluations are given based on the best-case scenario, the worst-case scenario, and the normal scenario.

    What is Startup Valuation
    First Chicago Method

    Book Value Method

    This method is used when the startup faces a loss and is going out of business. The valuation is done considering only the tangible assets of the company. Growth, revenue, branding, etc., do not matter.

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    Any method on its own is not sufficient to get a correct estimate. The best approach would be to evaluate the startup using multiple methods. Those methods on average will give us an approximately accurate guesstimate. Not to mention some methods are merely qualitative. Valuations are handy when you turn to fundraising.

    There is no hard and fast rule when it comes to scoring funding. Sometimes, the person, the brand, or the team might convince the investor rather than the calculated numbers. It is a matter of skillful negotiation and instilling faith in the investor that your company deserves the funding.