Introduction to Startup valuation
At the time of investment and negotiation, valuation is the primary determinant of returns for investors. Obtaining all relevant information and knowing the company well is critical to an accurate valuation and thus to investment success.
In some early-stage investment negotiations, each party withholds information and tries to convince its opponents by showing information that does not correspond to reality. However, the goal of investment negotiations should be for investors and entrepreneurs to share information as openly and fully as possible and to work together towards the common goal of building successful businesses.
At the time of investment and negotiation, valuation is the primary determinant of returns for investors. Obtaining all relevant information and knowing the company well is critical to an accurate valuation and thus to investment success.
Unfortunately, valuation is often misunderstood and this leads to endless negotiations that get the relationship between entrepreneur and investor off to a bad start.
The problem is that most entrepreneurs and investors have very different views in terms of investment language. Entrepreneurs generally do not understand the difference between the growth rate of the company's valuation and the valuation of the shares received by investors due to dilution by subsequent investors and other factors.
A simple example may help clarify the issue: An investor finances at a subsequent valuation of $8 million and receives shares valued at $4 each. The company is sold in six years for $120 million, a 15x increase in the company's valuation. However, due to dilution, the value of the investor's shares will almost certainly not have increased 15x to $30 per share. Instead, it may only have increased 3x to $12 per share.
Understanding these concepts will help to ensure that negotiations build an effective working relationship between investors and entrepreneurs.
UpValuations startup valuation approach
UpValuations is based on a combination of 5 valuation methods that are compliant with the IPEV (International Private Equity and Venture Capital Valuation) guidelines.
What are the IPEV Guidelines?
After this, you have a good baseline of what the best practices are and how are usually formulated
Scorecard method
Takeaway:
The Scorecard compares the startup (raising angel investment) to other funded startups modifying the average valuation based on factors such as region, market, and stage.
Financing round method
The financing round method is based on public market data and qualitative information. Total amount of equity raised serves as a basis for the valuation of the company.
Go to moduleRead time: 3.0 minutes
Pre-money multiple = Last financing round pre-money valuation / Total amount raised after round
Venture capital method
Take aways:
The venture capital method is most commonly used in the venture capital industry and for valuing startup ventures. Investors will seek a return equal to some multiple of their initial investment or will seek to achieve a specific internal rate of return based upon the level of risk they perceive in the venture.
Discounted cash flow method
Description of the Discounted cash flow method and its use cases
Go to moduleRead time: 4.0 minutes
Take aways:
Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment based on its expected future cash flows. DCF analysis attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future.