Fundamentals of Startup Valuation
November 19, 2021
At various stages of the growth and development of a company, every startup business needs a valuation. A business valuation helps you see if you are on track for expansion, further investment, or even for pre-empting an exit plan later down the line.
A business is only as valuable as someone is willing to pay for it and explicitly wants to invest in funding startups.
Many investors want to fund startups because the potential for rapid growth is more enticing than investing in a mature company with slower growth and less potential.
But how easy is it to get a business valuation so that you are ready to attract investors? Is a business valuation the same for every industry? Do you need external help for a business valuation, or can you do it yourself, with a bit of guidance?
This post provides the fundamentals of startup valuation, which will help you decide how much, if any, help you need to get a business valuation for your startup.
For finding investors wanting to fund startups, a business valuation can help improve your chances of securing funding.
What is a Business Valuation?
A business valuation is a way of determining the current market value of your business.
A company valuation can help to:
- Secure investment – investors want realistic figures to determine their interest in funding startups as they want to invest in businesses with high-growth potential.
- Establish a fair price for employees – to buy and sell shares in the company.
- Secure funding – if you want to expand the business, a yearly valuation can help secure funding from sources eager to fund startups.
- Tax returns – you may need to provide valuation figures on your company tax returns.
- Establish a business partnership – or for buying out an existing business partner.
It can be tricky to figure out the right business valuation method, and if you're finding it too easy, it might be an idea to combine a few business valuation techniques. Investors eager to fund startups may have prerequisite business valuation methods they prefer before they invest in businesses.
What Affects Business Valuation?
Some parts of your business may be easier to value than others, such as stocks and fixed assets like equipment, property, and land. But it's not so easy to value intangible assets.
For instance, how do you value the business reputation, its customers, and how valuable are the company trademarks?
Other things to consider when valuing your business –
- What are the circumstances of the valuation? – is it a voluntary valuation or a forced sale, for instance?
- How long has the business been established? – startups may be making a loss but have bags of potential. An established business could be making healthy profits but could be in a declining market for the business type.
- How strong is the team? – a stronger team may contribute to the value of a company.
- Types of products – can be a significant factor in determining value, depending on the value of products, stock levels etc.
Different Ways of Business Valuation
There are several unique approaches to valuing your business. It's preferable to use at least two objective methods of business valuation.
Price to Earnings Ratio (P/E)
The P/E Ratio (price to earnings ratio) is a way of valuing a business with a measurable and established track record of company profits. For instance, a business with a high forecast for profits could indicate a higher P/E ratio, likewise for a business with good records of repeat earnings.
For example, a UK company with a P/E ratio of four, making £250,000 post-tax profits, would be valued at £1,000,000.
High growth companies, such as tech startups, often have higher P/E ratios. Mature businesses like real estate will have lower P/E ratios because the growth potential is steadier.
P/E ratios differ according to variables even in companies of a similar type, turnover, and profits. But, that said, business advisors suggest a P/E ratio of between four and ten is ideal.
Investors may want to invest in businesses with a higher P/E ratio because they prefer the exhilaration of working with the higher-growth potential of funding startups.
If you were to start this business again, from scratch, how much would it cost?
Undoubtedly, if this business is your first startup, you may have learned better ways to raise funds. Add up startup costs and tangible assets, product development, recruiting and training staff and costs of building a new client base—factor in what savings you could make, such as cheaper premises etc.
Business Assets Valuation
Work out the Net Book Value (NBV), recorded in the company accounts. Be realistic when valuing assets, taking stock depreciation into account, and any changes in property value. Then subtract the business's total liabilities, and you then have an accurate valuation of your business assets.
Discounted Cash Flow (DCF) Method
The DCF method assesses future cash flow for a business and then estimates what that is worth today. DCF is a bit complex and not ideal for measuring the value of startup businesses. It is better suited to more mature companies with predictable cash flow.
Industry Rules of Thumb
Some industries use the rules of thumb as a guideline for business valuation, based on various aspects for particular business sectors and not just profits.
For instance, some businesses are valued on turnover, the number of customers and outlets. Check to see if your industry has rules of thumb guidelines because it's an effective way for a buyer to determine value to get the business operations up to industry standards.
The liquidation value is the net cash amount after clearing liabilities and liquidating assets.
How to Improve the Value of Your Business
Valuing your business can help steer the focus onto areas for improvement.
Before considering a valuation, it's essential to prepare so you can get the best valuation possible for your business.
- Plan ahead - focus on preparing a solid business plan outlining strategies for short-term and long term goals.
- Reduce risk – for instance, if your customer list is weighted for a particular group, the business could take a financial hit if the company lost customers in that sector. Spread the business risk by diversifying as much as possible.
- Have solid company processes – the better the company processes, the more chance of a favourable valuation. Assess how the company currently stores information, for instance. Improvements in streamlining processes encourage greater confidence from potential investors.
- Play to team strengths – make sure your team is working to their best in the right departments. Investors look for effective management and team activity. Be objective and look at the weakest links and take action to improve.
Hiring a Business Valuation Expert
Undertaking a business valuation is not an easy task. It can be time-consuming, laborious and distracting for your business. Plus, it can be challenging to remain objective regarding value.
Hiring a business valuation expert whose job it is to help you get the best valuation for your business might be a preferable option for many startup companies.
There are several country-specific or global certifications for professional business valuation accreditation, and you may find it quicker and easier to hire an expert.
In the United States, the ABV (Accredited in Business Valuation) is the recognised certification for specialist accountants, such as CPAs, who can calculate the value of a business. Overseen by the American Institute of Certified Public Accountants (AICPA), it's not a one-off certification. Those awarded must maintain their certification status with lifelong learning and adhere to minimum standards.
The Canadian Institute of Chartered Business Valuators (CICBV) is a professional qualification in Canada, issuing the CBV (Chartered Business Valuator) to qualified candidates.
Most countries have country-specific business valuation accreditation, but there are global qualifications such as ACCA Global, who issue the Certificate in Business Valuations, CPD learning.
If you need expert help with your business valuation, it's best to find a recommended business valuation advisor you can trust.
If you are an investor eager to fund startups with bags of potential, take a look at Startup Scout by Leadspicker. Startup Scout is a great way to find the best startup companies looking for an investor interested in funding startups. When you are ready to find and invest in funding startups, Startup Scout can be an excellent investor source.
There are several ways to get your business valued, and what works for one company may not work for another. If you have an investor interested in funding startups and want you to provide a valuation, it's worth asking what method they would prefer.
This post gives you a few ideas of the fundamentals of startup valuation. Whichever method you decide to use, always prepare well and remain objective in your assessments, which can be hard to do.
Some startup companies find it preferable to hire an independent business valuation expert experienced in understanding how to get the best valuation for your startup business.
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