How to Value a Startup Business
The Importance of Business Appraisals to Pre-Revenue Companies
Knowing and understanding your startup’s worth is essential to raising capital and seeking investment. But how do you truly understand where your startup is and where it’s projected to go? Business valuations provide the key to understanding this crucial information.
Learn more about the importance of business valuations for startups with our comprehensive blog category page on business valuations for startups.
How Does a Business Valuation Benefit Your Startup?
Pre-revenue business valuation is an essential event for owners and investors alike. For the company’s owners, a startup business appraisal will show how much the company can raise. For potential investors, a startup business valuation will demonstrate a company’s growth potential and the amount of equity it can receive.
Many investors will desire a higher projected value, as investing in startups often results in equity ownership. However, it is important not to over-inflate a pre-revenue valuation in anticipation of this. Keeping projections realistic will help avoid over-promising and under-delivering to investors. It is important to balance showing the highest value of your business possible while maintaining the most accurate value.
Please read our article on valuing startup equity.
A Realistic Startup Company Valuation
A realistic, comprehensive company valuation will help investors determine whether your company is a good fit for them and help your startup secure the investment and funding it needs. Knowing your startup’s projected value will arm you with the tools needed to grow it successfully and maintain preparation for any financial event.
Learn more with our guide on everything you need to know when valuing a pre-revenue startup.
How Does Valuing Startup Companies Differ from Valuing Established Businesses?
When business valuations are performed for well-established businesses, the process is backed up by strongly established financial data. When valuing startups, this history of financial data is not yet present in the early stages of business. Because of this key difference, valuing startups will involve deep-diving into the factors determining a startup’s likelihood of success.
Please read how to value a company for investors.
Valuing startups is a process that is even more highly nuanced than a traditional business valuation, and determining the most accurate value possible requires a delicate hand. As many say, business valuations are more of an art than a science, and startup valuation methods are no exception to this rule.
At Business Appraisal FL|GA|HI, all our business evaluators are accredited in business valuations. They are Certified Valuation Analysts (CVA), and we are fully qualified to help you find the most precise value of your company. Many of us have built our own companies ourselves, and we understand the unique circumstances that your startup brings.
Know the benefits of business valuation services with our article on the top 7 benefits of getting a business valuation.
What Factors Influence Startup Company Valuations?
When a company is pre-revenue and has no financial history on which to base the valuation, other measurable factors create a picture of a business’s pre-money valuation. Some of these factors can include:
- Founder experience
When the startup’s founders or management have already proven themselves in other business ventures, this experienced background increases the likelihood of the new startup’s success, further increasing its value.
- Level of development
How far along in development is the startup’s product? From simply an idea to a fully developed product, the level of how much can be shown for a product can increase the startup’s credibility and the investor’s confidence in success.
Learn more about how to value your business.
- Market size
Larger markets result in a larger profit potential. So, the larger the market a startup is entering, the larger the startup can be projected to grow. Please read our article on the differences between valuing small and large companies.
- Potential for industry disruption
In a market saturated with the same types of businesses, there is little more valuable than innovation and disruption. In addition, the potential of a startup to bring something truly unique to the world and disrupt current market control will show a higher projected value.
Is your business based in Florida or Georgia? Read our article about why now is the time to get a business valuation in Florida or Georgia.
What Startup Valuation Methods Are Suited to Startups?
Thanks to the unique challenges and situations that valuing startups brings, different valuation approaches are often recommended than the methods traditionally associated with business appraisals.
- Berkus Method
Developed by an angel investor named Dave Berkus, the Berkus method is simple and based on qualitative data. It examines five essential areas of a startup and determines a value ranging from zero to $500,000 for each area.
These five startup valuation methods are:
- Business Idea – The company has a sound business idea or business model.
- Quality Management Team – An exceptional, credible management team runs the company.
- Product Rollout – The company shows a strong path toward revenue growth.
- Strategic Relationships – The company has strong business relationships.
- Prototype – The company has a developed product or prototype, which is the value of IP or intangible assets.
Because the maximum amount for each area is $500,000, the maximum startup valuation with the Berkus method is $2.5 million. This method often expects a projected value of $20 million in the 5th year of business, so once the original value has been assessed, it can be determined if the startup is likely to reach this goal.
Please read our article on pre versus post-money company valuations to understand this area of startup valuation methods.
- Risk Factor Summation Method
The risk factor summation method will consider several risk factors for pre-revenue startups.
The most common types of risks include:
- Stage of business
- Management
- Funding risk
- Capital risk
- Burn rate or cash flow risk
- Technology risk
- Competition risk and strategic relationships risk
- Political risk
- Legislation risk
- International risk
- Potential lucrative exit
- Reputation risk
- Marketing risk
An investor will assess the risks of your pre-revenue startup using this guideline:
-2: very negative, subtract $500,00
-1: negative, subtract $250,000
0: neutral, $0
+1: positive, add $250,000
+2: very positive, add $500,000
By analyzing pre-revenue companies using this method, investors can understand the potential risks and rewards and determine whether the start-up is suitable for their investment.
- Comparable Transactions Method
The comparable transactions method involves comparing your startup to similar startups that are further along on their path and asking how much it would cost to acquire these similar companies. You will also see the term cost to duplicate approach.
The valuation number for this method will be produced by determining revenue multiples for comparable businesses in the same industry as yours. If a comparable company with similar assets produces 6x to 8x more than the prior year’s sales, you may assume that your business’ revenue multiple will go a similar route.
Looking to value a small business? Please read our article on what you need to know about small business valuations.
Pre-money versus Post-money valuations
Pre-money and post-money valuations are key concepts in understanding a company’s worth, especially during funding rounds. Here’s a breakdown of the differences:
Pre-Money Valuation: A company’s value before receiving any external funding or capital injection.
• Purpose: Helps investors understand the company’s value based on its current assets, intellectual property, and market position without considering new investments.
• Example: If a startup is valued at $1 million pre-money and an investor injects $250,000, the pre-money valuation remains $1 million.
Post-Money Valuation: A company’s value after receiving external funding or capital injection.
• Purpose: This reflects the company’s value, including the new investment, providing a more comprehensive picture of its worth.
• Example: Using the same scenario, if the startup’s pre-money valuation is $1 million and it receives a $250,000 investment, the post-money valuation would be $1.25 million.
Why It Matters
Understanding the startup valuation difference is crucial for both entrepreneurs and investors to negotiate ownership percentages and make informed financial decisions. For instance, in the example above, the investor’s $250,000 would represent a 20% ownership if the startup valuation is pre-money but only 16.67% if the valuation is post-money.
Pre vs. post is critical when valuing stock options for employee compensation. Venture capital firms want key employees to pull in the same direction, knowing they are competing against other Silicon Valley companies.
Business Valuations for Startup Companies
Ready to know the true projected value of your startup? Reach out to BA FL|GA|HI today for a free, confidential consultation with our valuation experts to discuss your situation, the valuation process, the methods of valuation, and if our business appraisal services are right for you.