There are certain things you need to calculate in order to fully understand the worth of your business. One of those things is the valuation for your startup business. As a business owner you probably ask yourself this all the time “how valuable is my business?”. Some people are just curious on what their business is worth. Some other people are considering selling their business. Valuation is more than just a number.
If you were to sell your business, how much would you sell it for? what measure of value is placed on your business by investors, shareholders, and the general public?
The valuation for your startup, better put, determines the economic value of a business for a variety of reasons. This includes sale value, equity partner ownership, taxation, and even exit proceedings.
So Why Is It Difficult To Find The Valuation For Your Startup?
Startups by definition don’t have a long track record of revenue, profit or cash flow. Georgene Hyuang, says that much of the valuation is done by looking at the marketplace of similar companies and understanding how the industry for a type of startup values the companies within it.
Startup valuation is the process of calculating the net worth of your business. For many new founders, these startup valuation methods are particularly important because they are mostly applied at a pre-revenue stage. Firstly, think of value beyond money terms and then think very well about the monetary value of similar companies. But, like so many things in the startup world, there’s more than one way to figure everything out. However, all can be classified under 2 major approaches to valuation.
1. Intrinsic valuation
The intrinsic value of a business is the now-value of all expected future cash flows. It is the cash flow your business is expected to generate in the future, being discounted into the value of the present. Investors would like to invest in a business that has a high and stable cash flow than one with a low cash flow.
2. Relative Valuation
In this case, we reach valuation by looking at market prices of similar businesses and comparing them. This comparison is based on certain metrics such as revenue. Thus, the logic is that if similar companies are worth 10x earnings, then the company that’s being valued should also be worth 10x its earnings. There are two common types of relative valuation models: comparable company analysis and precedent transactions analysis.
These are the best methods for finding the valuation for your startup
A. Discounted cash flow method (DCF)
This is the most common valuation methods. This method finds out the intrinsic value of your startup by calculating future cash flow and discounting it. The discounted cash flow (DCF) formula is equal to the sum of the cash flow in each period divided by 1, plus the discount rate raised to the power of the number of years.
This method considers the time value of money. Therefore, when calculating the present value of future income, cash flows that will be earned in the future must be reduced to account for the delay.
Let’s look at an example: Mama Peace Shop
READ MORE: Use this hack to grow your customers base x10
Mama Peace Shop is a Supermarket that started 6 months ago and has caught the interest of potential investors. So far, they have a CEO, a book keeper and a sales/marketing manager. For 6 months, they were able to sell consumer commodities and their balance sheets had the results;
Cash ₦25 million
Inventory ₦65 million
Plant properties and equipment ₦40 million
Total ₦130 million
Loans ₦52 million
Equity ₦40 million
Retained earnings ₦38 million
Total ₦130 million
The projected cash flow for this shop would be
a. Year 1 100
b. Year 2 130
c. Year 3 150
d. Year 4 150
e. Year 5 170
If we assume that the business has a discounted rate of 6.8%. The value of this business will be ₦15.2 million. How? Do not worry, I will explain.
Discounted rate expresses the time value of money. It can make the difference between whether your business is financially viable or not. The lower your discount rate, the higher your valuation.
This valuation is achieved when you divide each years cash flow amount by 1plus the discounted rate and raising the amount to the number of the year. i.e year 1 for instance, the above statement would read;
We reach the valuation after calculating this value for all the years and summing them up.
B. Book Value Method
This is another very easy way of valuing your startup. We call is the “net-worth of a business”. Book value is the difference between all the assets and liabilities (without the equities and retained earnings). Using the earlier illustration, the book valuation of the firm would at ₦78 million.
C. Berkus method
This method is also one of the best in valuing a start up enterprise. The Berkus Method assigns a number, a financial valuation, to each of the major elements of risk faced by all young companies. This method was invented by an angel investor, Dave Berkus and was updated 20 years later. I will explain this in another article.
D. Scorecard Valuation Method
Also known as the Bill Payne Valuation method is also one of the most effective methods used by angel investors to value start up companies. This method compares the startup to other funded startups based on factors such as region, market, and stage. In simple terms, the scorecard company valuation helps investors find an average valuation for startups that are able to grow, but with no revenue yet. This method uses weighted percentages and market data to determine an acceptable average.
You can use the scorecard method to compare your company to other similar companies in the industry. The basis on which they compare the companies are the stage of development, business sector, and geographic location.
E. Risk Factor Summation Method
The Risk Factor Summation method (RFS) is a rough pre-money valuation method for early-stage startups. This base-value receives adjustments for 12 standard risk factors. This means you compare your startup to other startups and assess whether you have higher or lower risk. The risks analyzed are usually management, stage of the business, legislation/political risk, manufacturing risk, sales and marketing risk, funding/capital raising risk, competition risk, technology risk, potential lucrative exit etc.
F. Earnings multiple methods
The earnings multiple methods of valuation is simply multiplying the earnings before interest, tax and depreciation by the multiple of profit from other similar firms. Multiple of earnings is one way to value a business. It involves multiplying a company’s profits by a certain number to end up with a value. Multiple of earnings multiplies the earnings (or income/profit) in order to come up with a figure representing the company’s worth in a sale.
Applications Of Valuation In Real Life
In Nigeria, a company’s valuation is essential to determine share capital which is an essential requirement in the CAC registration. This is just like when a child is born into the world, he/she is immediately issued a certificate at birth to confirm his existence amongst many others. Afterwards, he or she will be identified as a person and is licensed to enjoy the benefits of a citizen or individual of that geographical location.
So, it is with a business. In addition, at the start of a business or the birth of a business, it is registered as a separate entity and this allows it to operate on legal grounds. It comes with the ability to access to business loans and sell shares.
Another importance of ascertaining the valuation for you your company is to determine its share capital. Determining a share capital is important to be able to determine how much individuals that require shares would buy. Furthermore, when share capital of a company is determined, individuals come to pay in exchange for a voting right in the company and the company accumulates equity financing.
READ: The ultimate guide for starting a POS business
However, there are also factors that can help you get a proper valuation for your startup
- Traction or company growth: Traction shows that a startup is taking off. In simple terms, traction demonstrates development and growth, which is why it is the most important aspect that convinces investors to invest money in a company.
- Prototype or sample: A prototype is an early sample or model to test the model of your business. If you are in the tech space, it is better to have one before calculating valuation.
- The Industry: The industry your business belongs to also aids valuation process. If it belongs to a booming industry like oil and gas, finance or FMCG, valuation would be relatively higher.
- Team Reputation: This also largely contributes in valuation process. A company valuation will definitely be high if the founder has strong reputation in relevant circles.
- Pre-valuation revenues: Before the company is valued, it may have made revenue from either testing or initial launch date. Undoubtedly, revenues are important for any company as they make it easier for investors to carry out the valuation. So, if a product has hit the market and is already generating revenue, it could sway the investor’s decision in the favor of that startup, and prove to be a real deal sealer.
EQUIDAM is a very trusted Valuation company that you can contact to also learn more about valuations and get your businesses valued. find them at www.equidam.com.
Meanwhile, you can look below to find some of our recent articles specially curated for you;
I am the lady with the numbers at OG capital. Graduate of accounting from Bingham university and a Business Valuation officer from CFI in view. Fun loving and kind. Living the life of christ