Summary
What is Private Company Valuation? A set of valuation methods used to determine the enterprise value of a private company.
The Enterprise Value of a Private Startup Company
Pre-Money Valuation or Startup Stock Valuation 101
Table of contents
Getting Start-up Equity? Everything You Need to Know About Exit Value
Joining a startup can be highly rewarding. A successful exit, whether through acquisition or IPO, determines the actual value of equity, highlighting the risks and rewards associated with startup investments. Join a growing enterprise, receive an equity grant, and make a meaningful industry impact. The equity in a startup compensation package often includes stock and salary. Seek an expert assessment of the potential equity offer from BA FL|GA|HI in startup valuations.
Please read our article on pre-revenue startup valuations.
What is a start-up stock valuation or the enterprise value of a private company?
Startup stock is a form of employee compensation where employees receive a portion of compensation in the form of shares. These shares have a vesting period and a strike price. Our business valuation uses “phantom stock” to describe equity shares distributed over time to retain employees. We also consider ownership percentage and minority interest.
Offering shares in the startup is a competitive tactic to attract potential employees. Once hired, this type of compensation incentivizes employees to perform well. Employees with equity in the startup may be more motivated to take risks and work longer hours, with the potential for significant earnings if the company goes public.
Startup Valuations or private company valuations
The value of a stock determines the potential payoff for startup founders and other shareholders in an exit strategy. However, the value of a stock depends on whether it is a share in a public or private company
Public companies can easily determine share value using ticker symbols on the stock market. Private startups, though, require the expertise of valuators like BA FL|GA|HI to assess stock value.
Understanding Startup Equity
What is startup equity, and how does it work?
Startup equity refers to the ownership percentage of a company that founders, investors, employees, and advisors hold. In other words, it represents a claim on a portion of the company’s assets and profits. Moreover, in a startup, equity is often used as a form of compensation, thus incentivizing individuals to contribute to the company’s growth and success.
Companies can grant equity in various forms, including common stock, preferred stock, restricted stock units (RSUs), and stock options. This form of compensation aligns the employees’ interests with the company’s success, as the value of their equity increases with the company’s growth and success.
This is why a timely startup valuation on a vesting schedule is so important.
Types of startup equity: common stock, preferred stock, RSUs, and options
There are several types of startup equity, each with its own characteristics and benefits. Common stock represents ownership in a company and gives shareholders voting rights, allowing them to have a say in corporate decisions. Preferred stock, on the other hand, has a higher claim on assets and dividends than common stock but typically does not come with voting rights. This type of stock is often more attractive to investors seeking a safer investment.
Restricted Stock Units (RSUs) are a type of equity that vests over time, allowing employees to receive shares of the company as they continue to work there. Stock options give employees the right to purchase company stock at a predetermined price, known as the strike price, which can be significantly lower than the market value if the company grows. These various forms of equity provide flexibility in structuring compensation packages and can be tailored to meet the needs of different stakeholders.
Who gets startup equity: founders, co-founders, advisors, investors, and employees
Startup equity typically distributes among founders, co-founders, advisors, investors, and employees. Founders and co-founders usually hold a significant portion of the equity, reflecting their initial investment and risk in starting the company.
Advisors and investors receive equity in exchange for their expertise and funding, which is crucial for the company’s growth and development. Employees may receive equity as part of their compensation package, incentivizing them to contribute to the company’s growth and success. This distribution of equity helps align the interests of all parties involved, fostering a collaborative environment where everyone is working towards the same goal.
Enterprise valuation methods
This is because to determine the current value of a share for a startup, you will need to divide the valuation of the venture by the number of shares outstanding. What percentage of total shares would you have as a percent of your market value and the tax implications.
The value of your equity is always the number of shares times the price per share. You determine the price per share by the valuation of the company divided by the total number of shares issued. If the stock multiplier keeps increasing, the expected value rises, and your company valuation confirms it, your potential wealth will increase.
Can you value pre-revenue startups?
We frequently conduct startup valuations to estimate the total value of new businesses. These valuations differ from appraisals of more established businesses, which typically consider factors such as profit analysis, taxation, amortization, and interest.
Analysts consider factors such as growth rate, marketing effectiveness, and customer base to evaluate a startup’s potential rather than relying solely on revenue and projected earnings.
However, even startups can forecast their future cash flows with the cash flow method and discount those cash flows back to their present value.
Calculate the enterprise value of a private company
Analysts should also evaluate the company’s founding team’s strength, as investors are unlikely to invest in a team unprepared for success. A successful team should have diverse skills, experience, and commitment.
Once assessed, the startup’s valuation, along with the number of shares currently available, will indicate the value of your offered shares.
How are pre-revenue startups valued?
There are a variety of pre-revenue valuation methods employed by analysts to assess the value of a startup. Two of the most common methods include:
1. Scorecard Method or Berkus Method
The Berkus Method is a widely recognized approach for valuing early-stage startups, particularly those that may not yet have significant revenue or established market presence. Developed by Bill Berkus, a prominent venture capitalist, this valuation method provides a systematic framework to estimate a startup’s worth based on qualitative factors rather than relying solely on financial metrics.
However, the management team adjusts the startup’s value based on factors like capital needs, industry competitiveness, and strength.
This method, named after its founder Dave Berkus, estimates the company’s value by assessing five key areas of the startup:
- The soundness of the startup idea and business model
- The value of the management team
- Whether the brand value prototype attracts customers
- The effectiveness of the company’s partnerships and strategic alliances
- Whether the company has upcoming product launches or expected sales
- The cost to duplicate approach
The sum of all the values results in the pre-revenue valuation for the startup.
2. Venture Capital Method
Investors primarily employ the venture capital (VC) method to estimate startups’ potential return on investment (ROI). This method revolves around the anticipated future exit value of a startup, typically through acquisition or initial public offering (IPO), and it incorporates several key components:
1. Exit Valuation: The first step involves estimating the future exit valuation of the company, which could be based on sector benchmarks, comparable company analysis, or projected earnings. This estimation is often calculated based on industry multiples, such as revenue or earnings before interest, taxes, depreciation, and amortization (EBITDA).
2. Investment Horizon: Venture capitalists consider the typical holding period for their investments—usually between 5 to 10 years. This timeframe is critical, as it aligns with the startup’s growth trajectory and the timing of its exit strategy.
What kind of equity might you be offered, and what is the equity value?
Your offer letter may mention receiving stock grants, stock options, or a combination of both. It is important to understand the type of stock you will receive as part of your compensation package and the funding rounds you are involved in.
Also, inquire whether the valuation of your startup company’s ownership shares is pre or post money, and if you receive the same treatment as angel investors and venture capital.
Please read our article on SAFE vs Convertible Note for startup funding company analysis.
Equity Grants and Vesting
What is an equity grant and how is it structured?
An equity grant is a type of compensation that gives employees the right to receive company stock or options. Equity grants are often structured with a vesting schedule, determining when the employee can exercise their options or receive their shares. The vesting schedule can be based on time, performance, or a combination of both.
For example, an employee may receive a grant of 1,000 options that vest over four years, with 25% vesting after the first year and the remaining 75% vesting monthly over the next three years. The fair market value of the equity grant is typically determined by the company’s valuation and the number of shares outstanding.
This structure ensures that employees are incentivized to stay with the company and contribute to its long-term success, as they will only receive their full equity grant if they remain with the company for the entire vesting period.
Business owners offering employees stock grants
Early-stage startups often offer stock grants that provide increasing shares as you vest. On the other hand, stock options allow you to purchase shares later at a predetermined price. As an employee, you can buy shares at a discounted price as the company’s value grows during your time with the company.
You can also read what is discount for lack of marketability since your shares will be in the minority for equity distribution.
How to Value Start-Up Equity Conclusion
Joining a startup with equity as part of your compensation is exciting. However, it’s important to do your due diligence and consider the job offer as a whole. Ensure you understand the company’s true value and assess if the startup has enough growth potential to justify joining. You should also consider the expected future value and the startup valuation methods used.
SBA lenders trust us to value private companies for SBA loans to calculate a company’s enterprise value or total market cap. The market capitalization of a private company can be much trickier than that of a public company whose stock is freely traded daily, and the cash flow can be lumpy.
Why Business Appraisal FL|GA|HI.
Reach out to BA FL|GA|HI today to discuss your situation, our expert appraisal services, the business valuation methods we use, and how we can help you assess your compensation offer and value your equity.
Let us give you the real equity value of a company via business valuations versus a guessing startup equity calculator or a meaningless book value.