How does an investor determine the value of a startup?
Estimating the value of an unlisted company but with an industrial history is easy. Conversely, the valuation of a start-up, possibly without customers, with no sales history turns out to be a complex operation to perform. However, there are different methods of determining the value of a start-up. What are the different possible approaches?
1. The “Berkus” approach
This method involves comparing your start-up with a company whose profile is very similar to yours. Five values must be taken into consideration: basic value of the start-up (project), technology, business model, capacity to launch the product and the qualities of management.
With this approach, you calculate the pre-money valuation of a start-up that has never generated revenue.
2. The sum of risk factors approach
The “Risk Factor Summation Method” is based on the Berkus approach. The first step is to determine the initial value of the start-up. The estimate obtained must then be adjusted according to 12 parameters intended to assess the quality of the start-up.
The following criteria are taken into account: maturity of the company, management, legal, industrial, commercial, financial, competitive, technological, legal risks, risks related to the export policy implemented, risks related to public relations, successful exit from capital.
The initial value is based on the average value of start-ups with a similar profile and located in the same geographical area. The risk factors are calculated in steps of € 250k, € 500k corresponding to a very low risk and – € 500k to a very high risk. This approach to the sum of risk factors is aimed at start-ups with no turnover.
3. The dashboard approach (“Scorecard Valuation Method”)
This method is more precise than the previous two. The first step is to apply the approach of the sum of the risk factors, calculation of the initial value of the start-up then adjustment according to various criteria weighted according to their degree of importance in the success of the project.
This approach also known as the “Bill Payne method” incorporates 6 criteria distributed as follows: management (30%), size of the opportunity (25%), product or service (10%), sales channels (10 %), maturity of the company (10%) and other factors (15%).
4. The “comparable transactions” approach
This method looks strangely like the rule of three. Depending on the start-up to be assessed, an indicator must be defined. This should provide a more or less exact idea of the value of the start-up. The indicator varies depending on the industry. For example, for the medical industry this may be the number of patents filed.
It is also possible, in the absence of an indicator, to take into account the turnover, the net margin or the gross margin.
5. The accounting approach
The accounting method is based on the value of all of the company’s “tangible” assets. In terms of valuing a start-up, the use of this approach is questionable as it only focuses on “tangible” assets. However, the majority of start-ups use intangible assets such as R&D, software, etc.
6. The net asset value approach
The net asset value corresponds to the estimated valuation when the start-up is placed in liquidation. The calculation takes into account the elements: furniture, equipment, stocks, etc. More concretely, this refers to all the equipment likely to be sold in the shortest possible time.
This valuation is based on the following principle: how much is it possible to obtain if everything the start-up owns is sold in less than two months? By default, intangible goods are worth nothing: intellectual property, brands, patents, etc.
The reasoning is this: intangible goods, to avoid liquidation, should have been sold, if they were not, then they have no value.
7. The approach based on discounted cash flow
The moment a start-up is on the rise, it generates positive cash flow. This therefore means that the value of the company is the sum of all flows accumulated over the years.
The method, based on discounting cash flows, is based on a more or less similar principle.
8. The “First Chicago Method” approach
The “First Chicago” approach can only be applied to a specific situation: “How to estimate the value of a start-up with low development potential? “.
The “First Chicago” method establishes three valuations: a scenario in which the start-up does not experience any growth, a scenario relating to a classic company which is developing little by little and the explosive growth “best-case”, the small start-up. up turns into an important company.
All three valuations should be calculated using one and the same method. The final valuation corresponds to the weighted average of the different scenarios.
9. The “Venture Capital Method”
This approach works according to the profitability objective defined by the investor. To determine the current value of the business, the investor assesses the potential risks that are likely to occur over the next x years.
The investor estimates that the start-up will be worth 100 million euros in 8 years? By doing a reverse calculation and taking into account the dilution expected during the next rounds of financing, you obtain an amount that corresponds to the amount that the investor plans to invest in the start-up.
The “comparable transactions” approach is used very often. Remember that a valuation is only an estimate of the real value of the start-up. Nevertheless, it allows you to know how your start-up is positioned in the market and the amount that you would be willing to accept for its sale. Thanks to these different approaches, the founders of startups are able to prepare a fundraiser.