Pre-Money Valuation or Startup Stock Valuation
Getting Start-up Equity? Everything You Need to Know
Joining a startup can be extremely rewarding. For some, doing so represents the opportunity to join an enterprise with growth potential. For others, it reflects the chance to join a team that hopes to make a meaningful impact in a particular industry or sector.
This opportunity is especially exciting for individuals because startup compensation packages often offer stock in the company in addition to the salary. Because of this, it is vital that you seek a proper assessment of the potential equity offer from experts like those at BA F|G in Startup valuations.
What is startup stock?
Startup stock refers to a form of employee compensation where the employee will have some portion of compensation in the enterprise. Shares tend to have a vesting time frame. Meaning they are distributed over time to retain employees.
Regardless, offering the opportunity for shares in the startup is a competitive tactic to recruit potential employees. Moreover, once hired, such compensation tends to incentivize great work. This is because employees with equity in the startup may be more willing to take on risks and put in long hours for the venture knowing that the potential for great earnings in the future — should the company ever go public — exists.
Startup Valuations
The potential payoff will greatly depend on how much the share is worth in the first place. However, determining how much a stock is worth will vary based on whether the stock refers to a share in a public or private company.
Public companies can easily determine the value of shares by searching for the company’s ticker symbol through the online stock marketplace. For startups that begin as private companies, however, determining the stock’s value is a bit more complex and requires the insight of valuators like those at BAF | G. 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. That is, what percentage of total shares you would have.
The value of your equity is always the number of shares times the price per share. And you determine the price per share by the valuation of the company divided by the total number of shares issued. Your potential wealth increases if that stock multiplier keeps going up.
Can you value pre-revenue startups?
We often conduct startup valuations to estimate the total worth of new businesses. This valuation will differ from the appraisals of more established businesses, which tend to consider an analysis of profits, taxation, amortization, and interest.
Although we often rely upon revenue and projected earnings to determine whether a startup company has traction among its customers. Analysts will try to determine if the company’s proof of concept has potential for ventures without revenue by considering its growth rate, marketing effectiveness, and customer base, among other factors.
Additionally, analysts might consider the strength of the company’s founding team because investors would be unwilling to invest in a team that does not seem ready for success. To gauge this success, a company team should have a staff with diverse skills, experience, and commitment.
Once gauged, the startup’s valuation — in combination with the number of shares outstanding — will offer insight into how much your offered shares will be worth.
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
Following this method, appraisers will consider other companies in the same industry and region to derive an estimation of value for the pre-revenue startup. However, the specific value of the startup is adjusted based on whether additional capital is needed, the competitiveness of the industry, and the management team’s strength, among other factors.
2. Berkus Method
This method, named for its founder Dave Berkus, results in a straightforward estimation of the company by assigning value to five crucial areas of the startup, which include:
- the soundness of the startup idea;
- the value of the management team;
- whether the prototype attracts customers;
- the effectiveness of the company’s partnerships;
- and whether the company has upcoming product launches or expected sales.
The sum of all the values results in the pre-revenue valuation for the startup.
What kind of equity might you be offered?
Your offer letter may say that you are receiving a stock grant, stock options, or a combination of the two. You must recognize what kind of stock you would receive as part of your compensation package.
Very early-stage startups will often offer stock grants, which offer greater shares as you vest. On the other hand, stock options enable you to buy shares at a later date at an upfront price that you can pay for the stock. Options tend to be offered so that as the company’s value increases during your tenure as an employee, you will be able to buy shares for less than they are worth.
How to Value Start-Up Equity Conclusion
Joining a startup offering equity as part of your compensation is exciting. Regardless, you must do your due diligence and consider the offer in its totality. To do so, ensure that you understand the company’s true value as you strategize whether the startup has enough growth potential to justify joining its team.
Reach out to BA F|G today to discuss your situation, our expert appraisal services, the business valuation methods we use, and the ways in which we can help you assess your compensation offer.
As a business owner, do you need help with your business valuation steps? Please call or contact BA F|G.
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