Valuation of a startup is a necessity for the entrepreneurs to raise the capital necessary for the business. With a value attributed to the business, it paves the way for easy liquidity as well. One can say that the valuation is a combination of both science and art which means you need the numbers generated by the scientific analysis while should also have the ability to value other immaterial aspects as well.
Since startups do not have a long record on their performance or revenue generation, the valuation is done based on the comparable companies in the market and how the industry has been performing in general. So if you are wondering on how to value a startup business, here are some methods you can try your hand in.
Venture capital method
In the year 1987 Professor Bill Sahlman suggested this method, and it uses the following formulas.
Here the terminal value is the expected sales price of the product in the future which is again an estimate calculated with reasonable revenue and earnings based expectations.
Discounted cash flow method
A famous method is using a prediction on the cash flow expected by the company and how much will be required for producing an expected ROI. Once this is calculated, a higher discount is applied to attribute to the risk faced by startups, on the perchance of their failure.
In this method, the ability of the market analyst is used for making assumptions which sometimes is more like a game of guessing for startups.
As we mentioned earlier, since there is no previous record for startups, similar companies in the market are taken into consideration for doing the valuation. Of course, factors that will vary between the companies are also taken into account for doing the valuation.
A correlation between a similar startup with its revenue or customer base is found which is then extrapolated to match the scenario of the startup undervaluation.
Apart from the methods mentioned above, there are multiple other formulas and methods that you can take into account. Of course, it is about your power of negotiation and convincing that will ensure investors see your business as a profitable one for investment.
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