How to calculate the valuation of your startup

Discover key methods, factors, and essential tips to determine the value of your startup and attract investors.

How to calculate the valuation of your startup

Wednesday July 05, 2023,

5 min Read

It is essential for founders and entrepreneurs to accurately value their startup to attract investors and venture capitalists, raise capital, negotiate stock deals, and make strategic business decisions. However, this is a complex process that requires careful consideration of multiple factors such as the company's financial performance, market potential, and competitive landscape.

Valuation methods

There are several ways to calculate a startup’s valuation. Let us take a look at some of the valuation methods. 

Income approach

This approach focuses on the startup's expected future earnings and cash flow. A company's value can be measured by predicting its future revenue streams, profitability and cash flow. This approach may involve using financial models such as Discounted Cash Flow Analysis to calculate the present value of expected future cash flows.

Market approach

This approach takes into account the value of comparable companies in the market. By analysing the deals and valuations of similar startups and companies operating in the same industry, one can gain insight into the potential value of the startup. This approach often uses valuation multiples such as price-earnings ratio and price-to-sales ratio derived from market benchmarks.

Asset-based approach

This method evaluates the net worth of a startup's assets and liabilities. This includes evaluating the fair market value of a startup's tangible and intangible assets such as property, equipment, intellectual property, and goodwill. The equity value of the startup is considered and the liabilities are subtracted to arrive at the net asset value on which the valuation is based. 

Berkus' approach

Developed by American venture capitalist and angel investor Dave Berkus, this approach focuses on evaluating startups based on a detailed assessment of Berkus' five key success factors: core values, technology, execution, strategic relationships in core markets, and production and resulting sales.

A detailed assessment on the monetary value associated with each of these key success factors is made. The startup valuation is the sum of these monetary values. The Berkus approach is also called the phased development method or the phased development evaluation approach.

Cost-to-duplicate approach

The cost of replication approach considers all costs and expenses associated with product launch and development, including the purchase of physical assets. All these costs are taken into account to determine the fair market value of the startup.

Future valuation multiple approach

This approach estimates the return on investment that investors can expect in the near future, in approximately 5 to 10 years. Estimates of revenue growth and costs are made for the forecast period. Then the multiples are applied to the relevant metrics to score the startup.

Market multiple approach

Market multiples are calculated using recent acquisitions or deals similar in nature to the startups under consideration. Then the startups are evaluated using the calculated market multiplier.

Total risk factor approach

The total risk factor approach evaluates startups by quantitatively considering all the risks associated with the business that can affect the return on investment. The risk factor summation method uses one of the other methods described in this article to calculate an estimated initial value for the startup.

This initial value takes into account the positive or negative impact of various types of business risks and subtracts or adds an estimate to the initial value based on the risk impact.

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Discounted cash flow method

This methodology focuses on predicting a startup’s future free cash flow. The return on investment, known as the discount rate, is then estimated. As startups are young companies and the investment involves a high degree of risk, high discount rates are usually applied. Future free cash flows are then discounted to their present value.  

How to choose the method that works best for you

Here are some factors to consider while choosing the valuation method.

Assess your audience and needs

Start by understanding your target audience and their specific financial needs. Consider factors such as demographics, accessibility, and existing financial infrastructure in the target area. This evaluation will help you determine the method that best suits your audience’s needs and preferences.

Evaluate scalability and customisability

Look for ways to provide scalability and customisability. Consider whether the method you choose can accommodate future growth and adapt to changing needs. Scalability ensures the solution can meet growing demands, while customisability allows the method to adapt to startup-specific goals and user preferences.

Consider data availability and privacy

Evaluate the availability and quality of data required for the chosen method. Ensure that relevant data sources are accessible and comply with data protection regulations to maintain data security and customer confidentiality.

Analyse cost and implementation complexity

Consider the cost and complexity involved in implementing your chosen method. Evaluate the financial resources required for development, integration and ongoing maintenance. Consider the long-term sustainability and affordability of the method for your startup.

Get feedback and collaborate

Connect with industry experts, consultants and potential users to gather their feedback and insights. Working with stakeholders can provide valuable insight into the suitability and potential challenges of different methods. Their input helps you make informed decisions and improve your approach. 

Entrepreneurs can determine a fair and compelling value for their startup by understanding the different valuation methodologies, assessing revenue and growth potential, analysing financial reports, and considering industry benchmarks. Seeking professional help and maintaining a realistic approach will lead to more accurate assessments. 

Edited by Swetha Kannan