A startup is a business in its infancy where oftentimes, there is nothing more than an idea, a small team or solopreneur, and a few physical assets. In order for a startup to turn an idea into a successful business, the founder(s) often require capital through investors. To gain investors, startups need to prove the value of their idea and the promise of a return on investment. This process is done through startup valuation.
The process of valuing a startup is tricky because the conventional valuation methods of utilizing historical financial statements are typically not available in early startups. Because of this, there is no one-size-fits-all approach to startup valuation, so many business appraisers and investors tend to rely on multiple valuation methods to get a clearer picture of the potential value of a startup.
Many large companies today have been derived from a startup and have since grown and scaled to become pillars in their market. Successful businesses like Pinterest, Ring, and Daily Harvest all have their roots from an initial idea that became an extremely profitable business.
Had these businesses not been able to place a valuation on their initial ideas, it is unlikely that their investors would have taken the risk to invest. Having a startup valuation is a crucial step in the startup processes, which reduces the perceived risk an investor takes when investing.
To value a startup, it is important to seek external expertise, value assets, calculate ROI, and learn how to forecast. A combination of all of these will give a clearer picture of the value of a specific startup, which will better prepare a startup to present these values to potential investors.
Seek external expertise
The failure of many startups has to do with the inability to do it all. Typically startups have a small group of individuals who have highly specific skills that have to do with the product or service being developed. This quality is important in the early stages to grow the platform or product, but expecting these same individuals to have expertise in finance, business structure, and valuation is unreasonable and will lead these individuals to be stretched too far. In the beginning, it is wise to outsource these responsibilities to experts in the field.
For startup valuation specifically, it is wise to seek out the assistance of a business appraiser or other valuable entrepreneurial opinions. Having highly trained and experienced individuals will give the startup the most accurate and credible valuation.
This part of the valuation is the most critical because an investor is less likely to believe an in-house valuation compared to an external one. Having outside sources will decrease the chance of bias and will give a more robust and credible valuation that an investor can rely on.
Business appraisers are typically the individuals that value a business before an investment, merger, or purchase. Business appraisers are highly trained to determine the real value of a business.
For startups, business appraisers will mostly rely on the calculation of physical and non-physical assets, as well as the value of the product within its given market. Analyzing these two factors allow an appraiser to make an educated valuation of the startup.
Entrepreneurial expertise relies mainly on the experiences that the entrepreneur has had in similar business ventures as well as being knowledgeable about what has historically been successful in the industry as a whole. Those with long-standing entrepreneurial experience are able to give ballpark valuations of a startup based on where they are in their growth, market advantages, team, and other qualitative l data.
In addition to being able to ballpark a valuation, seeking advice from an experienced entrepreneur is key as this person can give vital insights into the market, what works within that market, and what not to do. Industry expertise has been shown to increase the chances of business success. By increasing your knowledge as much as possible about your industry, you strengthen the startup, which can help in a valuation.
Determine the value of all assets
One misconception is that a business is evaluated only on its physical assets when in reality, the most valued assets are not those that you cannot readily purchase.
When considering a valuation, it is important to ensure the value of all assets is accounted for. This should include the physical assets but more importantly, includes intangible assets such as talent, user base, etc. These are the items that make the startup unique and also tend to hold the highest value with investors.
The typical tangible items that can substantiate any valuation include the investments of a property, its location, vehicles, computing infrastructure, inventory, and equipment. These are often the first to be valued because the process of determining the value of a piece of equipment or a fleet of cars is relatively straightforward. The same goes for the physical location and real estate of a startup because these are frequently marketed items and it is easy to compare what value these goods are being sold at.
These assets mainly are a derivative of how far along a startup is. The further into product or service development a startup is will usually correlate with the number of tangible assets they have.
The less typical items include the intangible like the worth of talent, user base, patents, and infrastructure. These items vary greatly from business to business and determining the value of something like an individual's skill set is difficult or intellectual capital.
Typically it is encouraged to outsource the valuation of intangible assets because it requires many complex analyses to determine the real value of these assets. Intangible assets are the reason investors invest and ensuring these assets are correctly valued is crucial in convincing investors they are making a wise choice by backing the startup and the team.
Return on investment (ROI)
While the valuation of assets is crucial in understanding the value of a startup, these valuations do not solely dictate the future worth of the startup, which is more important to investors.
Convincing an investor that your startup has value is the start, but proving that it will hold even more future value is what will earn their backing. The reason an investor puts money forth to a venture is in the hopes that they will turn a profit. This concept is also known as return on investment (ROI) and is a major selling point for investors.
As a startup, having a highly profitable product will yield the best ROI. Of these, technology-based service ventures and startups tend to have the highest return on investment because there are very few physical materials that need to be produced and shipped. Reducing cost and maximizing profit will result in a highly competitive product that is sure to interest investors.
High profitability is desirable for inventors because it is an indicator that they will have a faster return than a product that has lower margins.
While having high profitability is important for an investor’s return on investment, an equally important component of the equation is the desirability and market of the product.
High profitability is only meaningful if there is a market for the item. A startup that has a genuinely novel idea with few to no competitors will allow the product to be sold at a much higher rate. If a market is highly saturated with similar services or products, it is less likely that the startup will be able to succeed.
For an investor, it is a balance to find a startup with a profitable item that is desirable and has an untapped market.
High profitability is desirable for inventors because it is an indicator that they will have a faster return than a product that has lower margins.
M13 Team
Forecasting
Financial forecasting is a vital part of any business and for a startup valuation, it is incredibly important. As discussed above, proving that a startup will be profitable in the future is of the utmost importance when trying to secure investor deals.
Forecasting is the best way to show that there is a business model and that the finances will work out as the startup gets off the ground and begins functioning.
One metric that can be achieved through forecasting is expected growth. Generally speaking, a startup grows in a sigmoidal like fashion, wherein the beginning there is little growth, followed by exponential growth that then tapers off.
Investors generally attempt to get into the business when the business has already undergone the slow growth phase and is expected to enter the large growth phase. This stage promises a quicker return for investors. Finding an investor during the slow growth phase is difficult because unfortunately, many businesses are never able to enter the large growth phase which means that as an investor, it is bringing more risk into the equation.
Another metric that can be utilized to value a startup is financial forecasting for fixed and variable costs. Planning ahead can mean the difference between a startup succeeding and one that becomes another dead end. A forecast for future expenses will show a drive to plan ahead and be proactive rather than reactive as the business grows. Expenses needed for growth and increased infrastructure are all growing pains that many startups need to perform to become a business, and by accounting for them in your forecasting, you are better able to plan for the amount of capital you need to raise. These models also show investors your game plan and how you will utilize their investment, giving them a better sense that their investment is being utilized in a worthwhile way.
Takeaways
In summary, accurately valuing a startup valuation requires a holistic approach.
The process of valuing a startup is very complex as the usual business valuation methods simply do not work without historical finances to work with. As a workaround, valuations look at the assets a startup has, and the future potential the startup will have. Many evaluators will utilize comparative models to determine the worth of a startup based on other similar startups, but this methodology only gives an estimate.
To find the value of the business one must look at the tangible assets, intangible assets, the product, its profitability, and the demand for the product.
As a founder, it is important to know how the valuation is performed to ensure your startup is valued as highly as possible. Getting a good valuation is a sure way to win over investors and get them to back your startup. As a founder, you need to ensure that your startup is backed by a unique idea, a solid growth plan, and great talent. All of these items can greatly increase a valuation and can give you an edge over the competition.
In addition to knowing the process, having experienced entrepreneurs to communicate with during the process is important. Trying to do a valuation without guidance will result in a poorer valuation but seeking the advice of others that have been through the process can give you an edge and allow you to learn from their mistakes rather than starting from scratch.
M13’s model was strategically developed to help support entrepreneurs in all aspects of starting and scaling their businesses, and serves as a valuable resource to founders during these stages. The initial stages of a startup are extremely important and having the help of others will give your startup success in today's competitive business landscape.
A startup is a business in its infancy where oftentimes, there is nothing more than an idea, a small team or solopreneur, and a few physical assets. In order for a startup to turn an idea into a successful business, the founder(s) often require capital through investors. To gain investors, startups need to prove the value of their idea and the promise of a return on investment. This process is done through startup valuation.
The process of valuing a startup is tricky because the conventional valuation methods of utilizing historical financial statements are typically not available in early startups. Because of this, there is no one-size-fits-all approach to startup valuation, so many business appraisers and investors tend to rely on multiple valuation methods to get a clearer picture of the potential value of a startup.
Many large companies today have been derived from a startup and have since grown and scaled to become pillars in their market. Successful businesses like Pinterest, Ring, and Daily Harvest all have their roots from an initial idea that became an extremely profitable business.
Had these businesses not been able to place a valuation on their initial ideas, it is unlikely that their investors would have taken the risk to invest. Having a startup valuation is a crucial step in the startup processes, which reduces the perceived risk an investor takes when investing.
To value a startup, it is important to seek external expertise, value assets, calculate ROI, and learn how to forecast. A combination of all of these will give a clearer picture of the value of a specific startup, which will better prepare a startup to present these values to potential investors.
Seek external expertise
The failure of many startups has to do with the inability to do it all. Typically startups have a small group of individuals who have highly specific skills that have to do with the product or service being developed. This quality is important in the early stages to grow the platform or product, but expecting these same individuals to have expertise in finance, business structure, and valuation is unreasonable and will lead these individuals to be stretched too far. In the beginning, it is wise to outsource these responsibilities to experts in the field.
For startup valuation specifically, it is wise to seek out the assistance of a business appraiser or other valuable entrepreneurial opinions. Having highly trained and experienced individuals will give the startup the most accurate and credible valuation.
This part of the valuation is the most critical because an investor is less likely to believe an in-house valuation compared to an external one. Having outside sources will decrease the chance of bias and will give a more robust and credible valuation that an investor can rely on.
Business appraisers are typically the individuals that value a business before an investment, merger, or purchase. Business appraisers are highly trained to determine the real value of a business.
For startups, business appraisers will mostly rely on the calculation of physical and non-physical assets, as well as the value of the product within its given market. Analyzing these two factors allow an appraiser to make an educated valuation of the startup.
Entrepreneurial expertise relies mainly on the experiences that the entrepreneur has had in similar business ventures as well as being knowledgeable about what has historically been successful in the industry as a whole. Those with long-standing entrepreneurial experience are able to give ballpark valuations of a startup based on where they are in their growth, market advantages, team, and other qualitative l data.
In addition to being able to ballpark a valuation, seeking advice from an experienced entrepreneur is key as this person can give vital insights into the market, what works within that market, and what not to do. Industry expertise has been shown to increase the chances of business success. By increasing your knowledge as much as possible about your industry, you strengthen the startup, which can help in a valuation.
Determine the value of all assets
One misconception is that a business is evaluated only on its physical assets when in reality, the most valued assets are not those that you cannot readily purchase.
When considering a valuation, it is important to ensure the value of all assets is accounted for. This should include the physical assets but more importantly, includes intangible assets such as talent, user base, etc. These are the items that make the startup unique and also tend to hold the highest value with investors.
The typical tangible items that can substantiate any valuation include the investments of a property, its location, vehicles, computing infrastructure, inventory, and equipment. These are often the first to be valued because the process of determining the value of a piece of equipment or a fleet of cars is relatively straightforward. The same goes for the physical location and real estate of a startup because these are frequently marketed items and it is easy to compare what value these goods are being sold at.
These assets mainly are a derivative of how far along a startup is. The further into product or service development a startup is will usually correlate with the number of tangible assets they have.
The less typical items include the intangible like the worth of talent, user base, patents, and infrastructure. These items vary greatly from business to business and determining the value of something like an individual's skill set is difficult or intellectual capital.
Typically it is encouraged to outsource the valuation of intangible assets because it requires many complex analyses to determine the real value of these assets. Intangible assets are the reason investors invest and ensuring these assets are correctly valued is crucial in convincing investors they are making a wise choice by backing the startup and the team.
Return on investment (ROI)
While the valuation of assets is crucial in understanding the value of a startup, these valuations do not solely dictate the future worth of the startup, which is more important to investors.
Convincing an investor that your startup has value is the start, but proving that it will hold even more future value is what will earn their backing. The reason an investor puts money forth to a venture is in the hopes that they will turn a profit. This concept is also known as return on investment (ROI) and is a major selling point for investors.
As a startup, having a highly profitable product will yield the best ROI. Of these, technology-based service ventures and startups tend to have the highest return on investment because there are very few physical materials that need to be produced and shipped. Reducing cost and maximizing profit will result in a highly competitive product that is sure to interest investors.
High profitability is desirable for inventors because it is an indicator that they will have a faster return than a product that has lower margins.
While having high profitability is important for an investor’s return on investment, an equally important component of the equation is the desirability and market of the product.
High profitability is only meaningful if there is a market for the item. A startup that has a genuinely novel idea with few to no competitors will allow the product to be sold at a much higher rate. If a market is highly saturated with similar services or products, it is less likely that the startup will be able to succeed.
For an investor, it is a balance to find a startup with a profitable item that is desirable and has an untapped market.
High profitability is desirable for inventors because it is an indicator that they will have a faster return than a product that has lower margins.
M13 Team
Forecasting
Financial forecasting is a vital part of any business and for a startup valuation, it is incredibly important. As discussed above, proving that a startup will be profitable in the future is of the utmost importance when trying to secure investor deals.
Forecasting is the best way to show that there is a business model and that the finances will work out as the startup gets off the ground and begins functioning.
One metric that can be achieved through forecasting is expected growth. Generally speaking, a startup grows in a sigmoidal like fashion, wherein the beginning there is little growth, followed by exponential growth that then tapers off.
Investors generally attempt to get into the business when the business has already undergone the slow growth phase and is expected to enter the large growth phase. This stage promises a quicker return for investors. Finding an investor during the slow growth phase is difficult because unfortunately, many businesses are never able to enter the large growth phase which means that as an investor, it is bringing more risk into the equation.
Another metric that can be utilized to value a startup is financial forecasting for fixed and variable costs. Planning ahead can mean the difference between a startup succeeding and one that becomes another dead end. A forecast for future expenses will show a drive to plan ahead and be proactive rather than reactive as the business grows. Expenses needed for growth and increased infrastructure are all growing pains that many startups need to perform to become a business, and by accounting for them in your forecasting, you are better able to plan for the amount of capital you need to raise. These models also show investors your game plan and how you will utilize their investment, giving them a better sense that their investment is being utilized in a worthwhile way.
Takeaways
In summary, accurately valuing a startup valuation requires a holistic approach.
The process of valuing a startup is very complex as the usual business valuation methods simply do not work without historical finances to work with. As a workaround, valuations look at the assets a startup has, and the future potential the startup will have. Many evaluators will utilize comparative models to determine the worth of a startup based on other similar startups, but this methodology only gives an estimate.
To find the value of the business one must look at the tangible assets, intangible assets, the product, its profitability, and the demand for the product.
As a founder, it is important to know how the valuation is performed to ensure your startup is valued as highly as possible. Getting a good valuation is a sure way to win over investors and get them to back your startup. As a founder, you need to ensure that your startup is backed by a unique idea, a solid growth plan, and great talent. All of these items can greatly increase a valuation and can give you an edge over the competition.
In addition to knowing the process, having experienced entrepreneurs to communicate with during the process is important. Trying to do a valuation without guidance will result in a poorer valuation but seeking the advice of others that have been through the process can give you an edge and allow you to learn from their mistakes rather than starting from scratch.
M13’s model was strategically developed to help support entrepreneurs in all aspects of starting and scaling their businesses, and serves as a valuable resource to founders during these stages. The initial stages of a startup are extremely important and having the help of others will give your startup success in today's competitive business landscape.
The views expressed here are those of the individual M13 personnel quoted and are not the views of M13 Holdings Company, LLC (“M13”) or its affiliates. This content is for general informational purposes only and does not and is not intended to constitute legal, business, investment, tax or other advice. You should consult your own advisers as to those matters and should not act or refrain from acting on the basis of this content. This content is not directed to any investors or potential investors, is not an offer or solicitation and may not be used or relied upon in connection with any offer or solicitation with respect to any current or future M13 investment partnership. Past performance is not indicative of future results. Unless otherwise noted, this content is intended to be current only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in funds managed by M13, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by M13 is available at m13.co/portfolio.