As you likely already know, using an intuitive method to calculate the value of your startup is an important first step to obtaining investments. But how do you calculate your startup’s value if you do not yet have revenue or are not yet making a profit?
Valuation methods for startups differ substantially from the valuation methods that established companies use, in large part because startup values are based on research and forecasts, rather than a company’s established financial trends. Choosing the most relevant valuation method for your startup can be a challenge, as each company is unique and requires methods that best represent you. So how do you choose?
This brief overview will help you differentiate between a wide range of valuation methods for startups so that you can find the method that results in the best representation of your company. Achieving investor readiness for your startup starts right here.
Key terms and concepts: valuation methods for startups
Before we consider a number of different startup valuation methods, let’s nail down some key concepts:
What are startup valuation methods and when do I need to use them?
Startup valuation methods help companies at the pre-revenue or pre-profit stages of development figure out how to represent their value to investors. Startup valuation is necessary so that you can appeal to investors as a startup with potential. The more value an investor sees in your startup company, the more she or he is likely to invest, and the faster you can begin taking in revenue. But because very few startups already have concrete values with which to work, startup valuation methods provide both subjective and objective parameters with which to quantitatively and qualitatively determine your company’s existing and expected value—so that investors know that they will see returns on the funds they invest in your startup company.
Why are startup valuation methods different from valuation methods for established companies?
Valuation is significantly easier for established companies than it is for startups. Companies that have been operating for a number of years simply need to take established values into account, or rather their EBITDA: Earnings before interest, taxes, depreciation, and amortization.
But most startups do not have concrete values for their annual net profit, interest, or taxes, etc. For pre-revenue or pre-profit companies, the vast majority of these values are based on estimation, forecasts, field research, and intuition. Instead of estimating value based on concrete numbers, startup valuation is based on less concrete qualifications and quantities like supply and demand, the hotness of the industry, prototypes, products, and competition.
Why is it important to choose the right startup valuation methods and how do I choose?
If you can convincingly demonstrate that your startup will garner a high value or will grow sustainably, investors are likely to invest more in your startup. Appealing to investors as a credible and promising company has a lot to do with how you represent your startup. Different startup valuation methods highlight different aspects of a company, and this is why you want to choose a method that will put your startup in the best light.
It is easiest to choose the most appropriate startup valuation method for your company once you know which elements of your startup are strong and which elements still need development. Which aspects of your startup should you emphasize? Our Valuation Method Check Tool helps you see which aspects of your startup will most appeal to investors and which aspects still need some work. Check out our valuation method check tool here.
Now that you’ve outlined the key components that will help determine your startup’s value, let’s continue by differentiating between some of the most popular methods of startup valuation.
The most popular valuation methods for startups
- The Venture Capital Method takes on the perspective of the investors by calculating the expected value of your company after a set number of years. It is primarily designed for pre-revenue startups and allows investors to calculate how much money they want to invest in your company now by calculating how much your company will be worth in the future, as well as your investors’ desired returns on their investment.
For more information on how the Venture Capital Method works and to use our Startup Valuation Calculator, visit our description and sign up for our online platform here: Venture Capital Valuation Method.
- The Berkus Method acts as a rule of thumb for pre-revenue companies based on the moves they’ve made to get their startup running. By assessing the quality and status of a startup’s “sound idea,” “quality management team,” and “strategic relationships,” among other values, the Berkus Method allows pre-revenue startups to assign value to their company according to “basic value,” “reducing execution risk,” and “reducing market risk,” and so on.
- The Scorecard Valuation Method widens the perspective of valuation to other startups in your field or region and is therefore more comparative than the other methods we’ve discussed thus far. By comparing the pre-money valuation of other startups in your area, you weigh aspects of your startup against the status and value of other companies, adjusting value according to criteria like “strength of your management team,” your “competition,” and the “size of the market” for your product. Each of these criteria is assigned a certain percentage that adds to your initial estimated startup value.
- The Risk Factor Summation Method is similar to the Berkus Method in that it assigns or detracts value from your startup’s project valuation based on a list of criteria. Your starting point is the average value of similar companies in your area. You then assess your company according to a list of 12 risk factors, such as “management risk,” “stage of the business,” and “competition risk.” If risks are high, you subtract value from your initial projected startup value. When these risks are low, alternatively, you add to your startup value.
Read more about the Risk Factor Summation Method and try it out for your startup by signing up for our key2investors platform and using our risk factor summation tool here: Risk Factor Summation Method.
- The Cost-to-Duplicate Method allows investors to calculate a low range of company value by focusing on how much money it would take to duplicate your startup business elsewhere. Unlike most startup valuation methods, the cost-to-duplicate method does not calculate your company’s future potential, but rather focuses on the value of the ideas, technology, and products you have already developed.
- The Discounted Cash Flow Method depends on three key values to calculate how much investors should contribute to your startup: your expected rate of cash flow over a fixed amount of time, the value of this cash flow against the original value of investment, and a discount rate for investors to account for the high-risk venture of startup companies.
- The First Chicago Method uses the Discounted Cash Flow method or comparable values to calculate the best, normal, and worst case scenarios. This method helps investors forecast both the high potential of your company and the risk involved in investing in it.
Find out more about how the First Chicago Method works and begin calculating your startup value by checking out our in-depth description and online tools here: First Chicago Method.
- The Valuation by Stage Method is a quick method for venture capital firms and angel investors to determine your startup’s risk factors and potential, primarily based on which stage of starting up you’ve achieved. If you’re at the initial stage of estimating the value of your company, investors will invest less to your project than if you’ve reached the more mature stage of producing a final product or accruing a solid customer base.
- The Comparables Method relies on values for more established startups that are similar to your own. By calculating the acquisition values and other criteria—such as concrete numbers related to customer base or online followers/active users—of more established startups, you can create comparative values for your own company.
- The Book Value Method is most relevant for startups that have tangible values, which typically excludes the vast majority of startups, whose values are based on expected growth. It measures the concrete values of a company’s assets, such as land, buildings, and physical products, to calculate a company’s existing net worth.
If more than one of these valuation methods seem to fit your startup well, that’s great! Different investors will appreciate different methods, and many investors will be interested in comparing your values based on two or more different valuation methods.
Of course, plugging in the variables to calculate your startup’s value based on a variety of valuation methods can be a lot of work. Save yourself the time and feel confident as you browse valuation methods for your unique startup by letting us help you. Sign up to take advantage of our wide range of tools and templates here and begin calculating your startup valuation today.