Revisiting Popular Startup Valuation Techniques

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14 startups have made it to the unicorn club in 2021 till now. Three made it to the decacorn club. Despite constant valuation skepticism, the Indian Startup Culture is clearly on the rise. And a way to validate and better one’s startup is through the means of suitable funding.

This is supported by the growing population of India; unemployment, innovation, and an incessant flow of novel ideas. This startup culture, which has seen a sharp spike since the 2008 Recession, has produced some of the best startups known to us – Zomato, Byju’s, and PayTM. However, these novel ideas can culminate into success stories only if they have the means, for which funding is mostly a necessity. Ergo, one needs to value their startup well.

Analysing a Startup’s worth is both an art and science; so many factors need to be considered before finally putting a monetary figure on the company. It’s comparatively easier to do the science, looking at the statements and using a financial technique. However, it is the art that is more puzzling. There are several variables on which there can be no price tag – the managing team, the supply chain, and the technology, to name a few. Yet, one needs to value these efficiently to get the net worth of the startup.

So, here’s a list of the three most considered startup valuation techniques:

Discounted Cash Flow (DCF): Probably one of the most popular techniques, this one looks at the company’s future. It focuses on the cash flow movements and the rate of return on investment in the near future. This return on investment (ROI), called the “Discount Rate,” is based on the cash flow projections.

However, since startups are novices and just starting in the game, there is a high factor of uncertainty involved. A high discount rate is applied to the investment because that high risk implies a more significant delay in generating sustainable cash flow.

One of the significant drawbacks of this technique is the ability to analyse the future. Since DCF works in the long term, it is essential to have a good understanding of the forecasting of market conditions and accurate projections. It is a sensitive technique that needs to be applied with great thought and care.

Cost To Duplicate: As the name indicates, this approach looks at the amount it would take to build another company, exactly like this one. It also looks at all the costs associated with building the company, including tangible assets. All of these expenses are considered to put a fair valuation.

It is primarily this approach that is initially used for valuing a startup since it is so objective and takes financials into account. However, one of the biggest problems with this approach is that one doesn’t take the company’s future as a variable here. More importantly, even intangible assets like the company’s reputation and brand value are not considered.

Market Multiple Approach: This approach looks at the recent acquisitions of similar companies in the industry and values them against it. A base multiple is then put on the company looking at the value of the recent additions.

One needs to put an x multiple when valuing it, depending on factors within the firm, too- like the stage of development. One must do enough research to know the sales and earnings to know where it will stand once the company has matured even more. Investors will also look at the business model and the type of product while investing.

However, there’s a drawback here. One may not always find companies with the same idea or size that emulate competitors. Extensive research, or worse, no company of that sort might exist, so it’s hard to apply this approach then.

As mentioned earlier, analysing a startup’s worth is both an art and science. It is essential to consider various factors and do good research before putting a monetary figure on the company.

The more puzzling art involves greater thought and precision. Factors like the brand legacy and future vision do not have a monetary figure attached but are essential in the long run. Even the industry dynamics and the founder’s mission are of great value. Managing teams, too, are pertinent to the success of the company. They are the ones running the logistics of the group and executing everything that is written on paper.

Moreover, it is vital to know the end goal of the company. Some founders may want to make an exit after the company reaches a specific valuation. Others may stay in it for the long term. One can also look at the spending patterns while valuing the company.

The valuations mentioned above are the most popular ones and are primarily used in the global startup culture. Besides the financials, it is recommended to take intangible assets into one company’s net worth. That way, one can put an accurate value on one’s startup.



Categories: Investment Basics, Op-Ed

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