Which valuation method should your startup use?

If you’re ready to start raising funds, planning your big exit, or benchmarking your startup’s growth, one of the first steps you should take is to determine your startup’s worth. 

As a new and growing company, you may not yet have a strong track record of earnings, which makes it hard to calculate the value of your company. But there are a few ways to compare your current revenue, potential growth, development stage, assets and other factors to determine the value of your company. 

Each of the following valuation methods provides a different perspective on your startup’s worth. For a basic understanding of your valuation, try one approach. Or, for a more robust idea of your total value, try using a combination of these startup valuation methods to calculate your full potential sale price:

1. Development stage valuation approach

The development stage valuation approach evaluates your startup’s value based on its stage of commercial development. By assessing factors like the size of your potential market, the strength of your competition, the quality of your leadership team and the technological soundness of your product, this method can be used to determine just how valuable your company currently is. 

The idea behind this approach is that the further along in development your startup is, the lower the risks associated with investing in it, and the more valuable the startup can be. If the startup only has a business plan in place, it may be considered minimally valuable. But if it has clear signs of revenue growth and is already moving towards profitability, it can be considered highly valuable. 

The development stage method is often used for startups that are still in the early stages of planning and growth, before they have a consistent revenue or earnings to evaluate. For that reason, this valuation method is often used by angel investors and venture capital firms looking for early-stage partnerships. 

2. Discounted cash flow method

The discounted cash flow (DCF) method estimates the value of a startup based on its expected future cash flows, discounted to the present value. DCF considers the time-value of money principle, which says money available now is worth more than it will be in the future, because money you have today can be invested to generate returns.

For early-stage startups, this approach to valuation is more complicated than the development stage valuation approach because it’s difficult to know what your startup’s future cash flow may be. There is a high level of uncertainty around future earnings, especially before market fit and demand have been established. 

3. Market multiple approach

Another way you can determine the value of your startup is to figure out your market multiple, and compare that to other recently sold firms in your industry. If you can find a handful of similar companies with a business model like your own, you can create a fairly accurate valuation close to what your investors will be willing to pay.

A multiple refers to how much a company sells for, compared to its annual sales. If a company in your industry recently sold for five times its sales, that company would have a multiple of 5. Startups are typically valued at a lower multiple, given their added risk. But the multiple method offers a simple way to compare the value within your industry and across multiple market players. 

The market multiple approach is another valuation method that can be difficult to use for early-stage valuations. If your company has yet to achieve consistent annual revenue, determining your sales multiple will require advanced forecasting to predict what sales will be, once your business is mature. Further adding to the challenge, early-stage deals are often kept private, which makes it difficult to find accurate information about the companies most like your own. Still, the market multiple valuation approach can be a favorite valuation method among investors, if accurate data is available. 

4. Cost-to-duplicate method

The fourth method you can use to value your startup is the cost-to-duplicate method. This method entails determining the fair market value of the assets your startup owns and has created, to calculate the literal cost to duplicate your business. 

Logically, an investor is not likely to invest more into a startup than they could spend to build the startup themselves. By calculating the value of what you’ve created, investors can determine an accurate value for your startup, and all the research, patents, and products that go with it. 

While this may be the most simple and straightforward valuation method, it’s not always the most accurate. The cost-to-duplicate method does not account for the potential earnings of your startup, and your intangible assets, like your brand recognition and reputation. That’s why this quick and easy valuation method is often used as a starting point or “lowball” method, while a more complex valuation is determined. 

Which valuation method is best for your business?

There’s no one-size-fits-all approach when it comes to startup valuation. The most suitable method for your startup depends on the specifics of your company, your stage of development and the goal of your activities. But by trying a few different methods and building a valuation based on multiple calculation approaches, you can determine a value your investors respect and your leaders deserve. 

Want more? Escalon can help ensure that your accounting, financial records and taxes are accurately done and that they communicate the full value of your business to potential investors and buyers. Talk to an expert today.

This material has been prepared for informational purposes only. Escalon and its affiliates are not providing tax, legal or accounting advice in this article. If you would like to engage with Escalon, please contact us here.

Author

Grace Townsley

As a professional copywriter in the finance and B2B space, Grace Townsley offers small business leaders big insights—one precisely chosen word at a time. Let's connect!