How do you value a start-up company?
Posted on 18/10/2019
Methods of Valuation
There is no black and white answer to valuing a company, apart from the one that both sides agree on. To determine that the value placed on your company is fair and valid, I am going to highlight some methods of valuation.
You do not need to use all these different methods of valuation but do use more than one. These will give you a price range, that although is not full proof, is more likely to be correct.
A couple of valuation methods to consider are:
· Minimum and maximum
· Discounted cash flow
· Asset valuation
· Cost to duplicate
· Market comparisons
· Stage valuation
Let’s explore these in more detail…
This is a good starting point. You should be asking for enough money to last 18 months and achieve a significant change to the company. If the investor buys less than 25% of the company, they lose some shareholder rights, and if you sell more than 40%, then you run the risk of over-diluting. You now know how much money you are asking for and the limits of how much of the company they’re buying.
Discounted Cash Flow
Discounted Cash Flow is used to calculate the value of a company today, based on the projections of how much money is generated in the future. It is based on the assumption that cash tomorrow is worth less than today because of inflation.
You take your projected cash flow for the next ten years and discount it to today’s value. This discount rate has to allow for risk and it is this that makes it hard to apply for early stage companies where the risk is at its greatest.
This means adding up all the assets within your company including buildings, equipment, work in progress and resources. It might also include grants awarded, but not drawn down. As an early stage company it is unlikely that you are asset rich, so this method is rarely effective.
Cost to Duplicate
This method questions what it would take for a competitor to consider, do I buy them or do it myself? So if you had to start your company all over again, assuming you are wiser now, how much would it cost? This does not take into account intangibles such as the connections you have made and brand values.
If I were to ask how much a two-bedroom flat is in your area, you would probably have a good idea. When buying a house, you can look at what price houses have been sold previously to gauge what is the expected price range.
You can apply the same method to buying a company. Investors have insight into what deals are being done and the expected price ranges for a company similar to yours. When calculating this yourself, you must consider objectively whether you are looking at similar companies at a similar stage of development.
The stage valuation method is a simple rules approach to what a company is worth depending on where a company is in its development. It is less nuanced that the market comparisons method and does not take into account different sector dynamics. If your sector does not fit this trend, is this because of the expected growth or level of investment needed to succeed?
It is often a complex decision between investors and a company. By trying these different methods of valuation, I hope it brings you more confidence in negotiating the value you place on your company.
If you’d like to learn more, you can hear Ian Tracey, Head of Access to Funding & Finance, talk about the art of valuing a company in this short video. (Also embedded below)
A2FF Team, KTN