Startup valuation for dummies, how

much is your company worth?

Guest Author | January 28, 2015 at 9:15 am

1847
One of my techie friend started a venture with two of his mates and they had
a product ready petty soon. This was relatively easy as they had the money
to build the product but now the problem arises that how he would launch
that product in the market? He needs money for which investors will have to
come into the picture. But before going to investors, he needs to figure out
the amount he requires and also value the product. And he doesnt have a
clue about how to do it. (how much is your valuation and equity dilution after
first round?)
Valuation is an important part that a founder or an executor always has in his
mind. Valuation matters to investors as they are getting the company share
in lieu of the money they are going to spent.
Let us see this situation with the help of an example:

In this above example, founder is looking for a seed investment of Rs. 1cr.
And the investors invest Rs. 1Cr. in lieu of the 10% of the equity. Typical deal,
the pre- money valuation will be Rs. 10 Cr. But this does not mean that the
company has Rs. 10Cr. worth now. Owners probably could not sell the
company for that amount.
Valuation at the early stages is a lot about the growth potential, as
opposed to the present value.
How to determine valuation?
Determine the value of the company at the seed/early stage is commonly
described as the art of describing the growth rather than a science.
Let us see what factors does influence the decision of the Investors:

Lets discuss these points One by one:

1. Hotness of the Industry:
Investors travel in packets just like they are going behind with others who
already take leads in the market. If something is hot and others are already
investing in the industry, they may pay a premium so as to stand in that
particular industry.
2. Pre-Valuation Revenues:
Revenues are more important for the startups. Revenues make the company
easier to value. In the initial stage if you have a functioning product and up
to the most the product is yielding the revenue from the market, then this
could be the most effective point that will affect the investor decision.
3. Reputation of the Team:
Before going to take a round for investment one must build his/her authority
or the image in the market. The most important thing what a VC looks is the
founder capability and his image in the industry or belongs to the particular
industry.
4. Traction:
Traction is a sign that your company is taking off. Traction is basically
quantitative evidence of customer demand. You can always get more traction
In other words, traction is growth. The pursuit of traction is what defines a
startup.
Out of all things that you could possibly show an investor, traction is
the number one thing that will convince them. The point of a companys
existence is to get users, and if the investor sees users the proof is in the
pudding.

5. Distribution Channel:
Even though your product might be in very early stages, you might already
have a distribution channel for it. This will help a lot for the VCs to get to
know what the startup is and can become the turning point of the decision of
that investor.
Methods of doing Valuation
Some of the valuation method that may be used in the valuation of a start up
or the methods by which the valuers find out the valuations of the
businesses:
1. Discounted Cash Flow Method:
This Method is the most usable and appropriate method to value the
company in the initial stage. The discounted cash flow method takes free
cash flows generated in the future by a company and discounts them to
derive a present value (i.e. todays value).
This Method mainly depends on the free cash flows that you are going to
earn in the future and affected by the various factors which includes the
inflations and unstabilities that will come in the market at the future stage.
2. Venture Capital Method:
The venture capital method reflects the process of investors, where they are
looking for an exit within 3 to 7 years. First an expected exit price for the
investment is estimated. From there, one calculates back to the post-money
valuation today taking into account the time and the risk the investors takes.
3. Market comparables method:
The market comparables method attempts to estimate a valuation based on
the market capitalization of comparable listed companies.
4. Decision Tree analysis:
Decision trees are used to forecast future outcomes by assigning a certain
probability to a particular decision.
The name decision tree analysis comes from the tree like shape the
analysis creates where each branch is a particular decision that can be
undertaken.
Does a startup need high valuation at initial stage?

It is not compulsory. When a startup gets a high valuation for the seed round,
then for the next round they need an even higher valuation and, that means
the startup needs to rise up in his position a lot. There are two ways of
looking at this:
1.

GO BIG or GO HOME: It means that in the seed round raise as

much as possible at the highest valuation possible, spend all the
money fast to grow as fast a possible. If it works you get a much
higher valuation in the next round, so high in fact that your seed
round can pay for itself. And, if it doesnt works then there is also
no problem.
2. Raise as you Go: Raise only that which you absolutely need.
Spend as little as possible. Aim for a steady growth rate. There is
nothing wrong with steadily growing your startup, and thus your
valuation raising steadily.
Conclusion
In conclusion, market forces right now greatly affect the value of your
company. These market forces can do a favorable job or unfavorable job for
the company in the field of the growth and yielding revenue from the market
for the appraisal of the company. The best thing a startup can do to arm
itself with a feeling of what values are in the market before you speak to an
investors is by speaking to other startups like yours that have raised money
and see if theyll share with you what they were valued and how much they
raised when they were at your stage. This will help a startup in getting better
valuation at an early stage.
Bonus Infographic from Funders and Founders on How Startup Valuation
Works Measuring a Companys Potential:

About the Author:

Agam Gupta is a practicing Chartered Accountant and also a founder
of www.Quickcompany.in, a leading website for registering company in India.