Ever imagined that why is Flipkart valued at billions in just 8 years whereas it took decades for many well established companies to do so? The number of unicorns (companies valued at over $1bn) and decacorns (valued at over $10bn) are pacing up faster than a wildfire. Just within a few years or even months the valuation of certain companies are so huge that only one word can explain them perfectly, astronomical.
Well established companies are valuated according to their revenues, organisation structure, future goals, and by many other such factors. But the question is how to value a company which has just started. It may even have not started generating revenues yet. What factors should be considered? But before discussing that let’s understand what is the ground scenario.
At early stages, valuation of a start-up isn’t its true value but how much of the company investor gets for his investment. It is just like a bargain deal. The idea is that an entrepreneur wants his/her company to be valuated as high as possible but an angel investor wants it to be valuated as low as possible so that he/she can own a larger portion of the company. Let us understand this with an example –
Let’s say you are looking for a seed investment of around $100, 000 in exchange for about 10% of your company. Typical deal. Your pre-money valuation will be $1 million. This however, does not mean that your company is worth $1million now. You probably could not sell it for that amount. Valuation at the early stages is a lot about the growth potential, as opposed to the present value.
Bill Payne puts it beautifully, “Much like the real estate market, the starting point for determining the valuation of seed stage ventures is comparable deals. At what valuation have similar deals at the same stage, in the same business segment and in your region been funded recently? Knowledge of local recent transactions is key to establishing the valuation of the target company. And, it is important to acknowledge that the valuation of startup ventures changes with competition (lots of capital chasing deals in a given business sector increases median valuations) and with the business cycle (angels are less likely to open their pocketbooks during a deep recession, driving down valuations).” Now let’s discuss a little about different valuation methods.
- Venture Capital Method: It calculates valuation based on expected rates of return at exit.
- Dave Berkus Method: It attributes a range of dollar values to the progress start-up entrepreneurs have made in their commercialization activities.
- Score Card Method: It adjusts the median pre-money valuation for start-up deals in a particular region and in the business vertical of the target based on seven characteristics of the company.
- Risk Factor Summation Method: It compares 12 characteristics of the target company to what might be expected in a fundable start-up company.
In these processes, many abstract things are given values (just like cow faeces are now part of our Indian GDP :p). A lot of companies may valuate a single company very differently. Every one of them follows a different method.
But you might be thinking what the problem with these methods is, right? Well there is a very serious one. VCs cannot fund a star-up forever. One day or the other, a company has to go public to raise funds. It is then when the problem arises. Before getting listed, the company would be revalued, using the conventional method of valuating any other company. This causes a landslide in the valuation of many start-ups. For a start-up, valuation is what decides how much of the company’s share they have it for themselves, and for most of the people it may even be the most important thing. A few companies’ valuations don’t fall much as they themselves decrease their valuation before going for an IPO. A few delay the IPO process and just drag themselves on.
So aren’t you curious to know more about this valuation scenario? The things discussed in this article are just the basics and may have missed many interesting points. But what is better than the experts themselves talking about the subject live in front of you? This eSummit, E-Cell IIT Kanpur is organising a panel discussion titled ‘Astronomical Start-up Valuation: The Fuzzy Math behind those Billions’.
NOTE: Example taken from fundersandfounders.com