How Accurate are Startup Valuations?

In today’s world, the term startup refers to any new business that tends to focus on developing unique ideas or technologies and introducing them into the market in the form of a new product or service.

Why is valuing a startup so different from valuing just any enterprise? We will answer this as you continue reading.

First things first, we in the finance world explain valuation as the process of calculating the present value of an asset or a firm. We all know that the true purpose of any valuation is to determine how much a third party will be willing to pay for this asset or firm.

With traditional valuations, when attempting to determine the value of a company, we require the following information

• Most recent financial statements, and financial statements from the past 5 years
• Any budgets, forecasts, projections or business plans created for the company
• Copies of all existing contracts
• Business ownership details including director lists, shareholder lists and ownerships stakes
• Information about transfers or selling of ownership stakes
• Full disclosure of any pending legal liabilities, debts, disputes or tax liabilities
• Information about customer retention and satisfaction
• Information on all company assets
• Most recent non-current asset appraisals
• Management reports disclosing product and sales information for the past 5 years
• Information on patents, copyrights or trademarks held by the company
• Information on any potential buyers

This list is not completely exhaustive, but you get the picture.

However, when it comes to startup valuation, most of this information is not available as most startups get valued before they even launch. This is why the methods and techniques of valuing a startup differ from the more traditional methods.

There are multiple methods you can use to value your startup, and we are going to list a few of them below with simple explanations:

• The Cost-to-duplicate Approach : As the name implies, this approach involves calculating how much it would cost to build a similar company from scratch. The idea behind this approach is that no investor will pay more than it will cost to recreate the exact same company.
• Market Multiple Approach : This is the most popular valuation technique used currently. The theory is based on the idea that similar assets sell at similar prices. Ratios used to analyse similar companies are compared to derive the average ratio, then that ratio is used to calculate the value of the startup.
• Discounted Cash Flow Approach : This is by far the simplest approach. It basically attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future.
• Risk Factor Summation Approach : This method uses the estimated initial value calculated for the startup (using any of the other methods discussed in this article). You then consider all possible business risks associated with the nature of the startup such as; political risk, management risk, technological risk, manufacturing and so on. Then you derive an estimate of these risks and apply them to the initial value.

As you can see, the plausibility of the results of each approach largely depends on the combination of estimated production output, sales, expenses, assets, liabilities and cash flow. All information you can find in any well researched financial model.

Now note that we used the word plausible to describe the valuations, because at the end of the day, the accuracy of a startup’s valuation is relative. It vastly depends on the credibility of the data that has been analysed, the insights that have gone into the financial modelling and the depth of market research conducted.

This is why MASAL consultants has partnered with VALUTICO, a valuation tool that provides access to reliable data sourced from all the leading financial databases, as well as analyst consensus industry estimates. This, combined with our experience in evaluating financial data from over 200 different companies, will enable us deliver a unique startup valuation experience. To find out more about this service, just sign up for a FREE Consultation and with one of our consultants.

Over the next couple of weeks, we will be discussing startup valuations and how to ensure you are getting the best possible estimated value of your startup. So please subscribe, to stay up to date with our posts.