Nordic startups have been doing well in 2019. Finnish company IQM raised €11.45M for their quantum computing hardware, Fintech Pleo raised $56M from a US investor and Minna technologies from Sweden obtained €5.6 M in another round of funding.
And while the numbers are inspiring to new entrepreneurs, they do beg the question: how do you value your own startup?
A quick online search reveals that it’s even more complicated than you might think. There are dozens of formulas, and nobody seems to be relying on the same one.
Which is why this article will focus on x8 tried and tested, actionable methods you can use to see how investors will value your startup. We have also compiled a cheat sheet so you can use to easily compare how different methods would change the valuations for your startup.
What Influences a Startup Valuation
Valuations are never set in stone. They vary a great deal depending on a number of factors, both positive and negative. And the main correlation, given the nature of startups, has to do with growth.
Here are a few examples of positive factors:
- Company traction: measured in active users. I.e. Facebook was already on track to gain its first million of users by the time it received nearly €500K from Peter Thiel in 2004.
- Team expertise: It’s no accident Pinterest was listed as Time Magazine’s Best website of 2011, months after it launched. The fact that founder Ben Silbermann came from Google certainly helped.
- Prototype or MVP quality: Brian Chesky and Joe Gebbia had difficulties paying rent for their San Francisco loft. Their took a few pictures, created a simple web page to attract temporary renters and soon enough had 3 paying guests. This is how AirBnB went from a successful prototype to a multimillion dollar business.
- Industry “hotness”: Launching a startup in the lift-sharing niche? The gold rush could already be over. Working with blockchain or machine-learning? These are hotter industries in 2019.
On the other hand, launching a startup in a niche or declining industry with large competition will affect valuation negatively. Poor management, buggy or faulty product and low margin projections will also affect how much money you can raise.
An Overview of Funding Rounds
With startup valuations, timing is everything. After the early seed money round (referred to as the F+F stage for Family, Friends and Fools), venture capital fundraising time frames are measured in “series”. So here’s your quick recap of the main differences between Series A, B and C.
- Series A funding: The very first funding round, and an important milestone for any startup. It provides early capital for the company in exchange for common stock for the early stage investors (VCs). The first injection of money will usually go towards building the team and product. Worth noting that, in the U.S. at least, around one third of startups raise Series A funds through accelerators.
- Series B funding: now that development is taken care of, this round is about taking your business to the next level. Your startup needs to have shown considerable achievements to access that second round of funds. In fact, it is often seen as the hardest funding round for any startups.
- Series C funding: entering the later stage investments. Investors are now looking to pour money into breakout companies with impressive traction. This round, and the following ones, are usually designed to appeal to potential acquisitors or to support an IPO. There is no limit to the amount of funding rounds a company can raise, going into Series D, E, F etc…
8 Formulas for Valuating Your Startup
In the following we have collected 8 of the most popular valuation methods, including popular favorites like Discounted Cash Flow or Scorecard Valuation Method. Feel free to save the infographics for later use – or just download our free excel sheet to make your calculations swiftly.
1) Discounted Cash Flow (DCF)
The Discounted Cash Flow formula, or DCF, is one of the fundamental models in value investing. Quite simply: it attempts to calculate how much a company will generate in the future.
To do so, it uses a discount rate, which expresses the time value of money. If the value calculated through DCF is higher than the cost of the current investment, the opportunity will become attractive to VCs.
2) The Berkus Method
In the 1990s, Angel investor David Berkus found that only 1 in 20 startups ended up hitting their revenue forecasts. This is why he devised his own method, which is based on a lot more estimation and eyeballing, and it’s favored by investors working with startups whose financial projections would not make sense. As Berkus himself wrote in his review of the method 20 years later, the matrix works great as a suggestion rather than a strict formula.
This formula starts with the idea that VCs should only invest in companies with potential to hit $20M in revenues by the 5th year.
Then there are x5 key points to evaluate, each worth up to €0,5M
- Quality of the management team: 0 – €0,5M
- Startup idea: 0 – €0,5M
- Working prototype: 0 – €0,5M
- Quality of the Boards of Directors: 0 – €0,5M
- Product rollout or Sales: 0 – €0,5M
3) Book Value
Probably the easiest valuation to perform on the list. Book Value simply refers to the difference between a company’s total assets and total liabilities.
4) Scorecard Valuation Methodology
The key to the scorecard method is to have a good idea of the pre-money valuation of similar startups. This is why it’s often used by investors who have experience in a specific area, or who have a long enough history to pull out insightful data.
In other words: it’s a valuation method that only works if you already have access to other valuations. Then it’s about working out weighted averages. Therefore creating an adequate “comparison” column is the most labor-intensive part of this method, often requiring in-depth research.
5 ) The Risk Factor Summation Method
This method requires a little bit more understanding or risk management and governance. It’s usually paired with another method.
Some of the risk parameters to include will be: management, business stage, legislation or political regulations, supply chain issues, competition, litigation etc… Like with the Scorecard Method, you will also need to use data from the average pre-money valuation for the considered sector.
6) Venture Capital Method
Another one for pre-money valuations, it takes into account expected ROI (return on interest rates) by the time the company exits the industry. Once again, it requires a good understanding of the valuation of similar companies in the same industry.
7) Comparables Method
The Comparables Method also involves a lot of research into similar startup valuations, and uses multipliers for comparing factors. You will need to benchmark similar companies and their funding, for instance by looking for other startup in your niché at the Hub or at CrunchBase.
8) Cost-to-Duplicate Method
Quite simply, this method pushes investors to imagine how much it would cost them to replicate the exact same startup in a different environment or market. Smart investors would stay clear of startups that can be duplicated cheaper elsewhere, for instance if labour costs or programming time has been inflated at the examined company.
Valuing Your Startup – Key Takeaways
One challenge startup founders and entrepreneurs face is that they often have to wear multiple hats at once. On top of that, they should also think like potential investors. This usually means the following:
- Research your industry: look at similar startups, business models, and even companies in the same area as yours. Look at your target market and how it’s likely to evolve in the next 2,3, or 5 years. Calculate the best case scenarios and the worst case ones too to get an average. Luckily, all these numbers are just a few Google searches away.
- Use more than one method: There is no magic bullet. You’ll need to average multiple valuation methods for a sensible number. Luckily, our free Excel template lets you calculate through multiple methods and see which one makes sense for your startup.
- Refine your calculations: To be realistic in your funding goals, you’ll need to refresh the data and continuously average results in your head. Geopolitics, industry news, market forces and even opinions from more experienced founders should help you reassess your results and update them.
In summary, yes valuation is mostly about predictions and guesswork. But it’s the only way to get a good idea of the true value of your company before others decide on what it’s worth.