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There are several different ways to calculate the startup valuation of a business for your investment. Essentially, the valuation of a business determines its worth. As an early-stage investor, the business’s value can help you calculate the worth of potential investments. Before calculating these valuations, you should know that the market forces of the industry and their sector greatly influence the startup business’s value. The balance (or imbalance) between supply and demand; the recency and size of exits; your willingness to strike an investment deal; and the entrepreneur’s need for money all influence the startup value. In this post, you’ll learn several methods to calculate the startup valuation of a business for your potential investment deal.
Market Multiple Method
One way to calculate the valuation of a startup business is to use the market multiple method. In particular, this approach is valuable in venture capitalist investments because it gives an approximate indication of what the market is willing to pay for the company. Basically, the market multiple method values the company against recent acquisitions of similar companies in the market. For instance, if mobile application software firms are selling for five-times sales, you can use a five-times multiple as a basis for valuing your potential mobile apps investment. Because you’re valuing a startup company, you likely have to adjust the multiple down to account for the larger risks entailed. The market multiple approach to calculating a business’s startup value can help you determine a reasonable investment for profitable returns.
The Berkus Method
Another way to calculate the valuation of a startup business for your investment is the Berkus Method. Dave Berkus created this strategy for when you envision the company breaking $20 million in revenue within five years. Importantly, his method assesses five critical aspects of a startup. These include concept, prototype, quality management, connections, and launch plan. Each aspect is given a rating up to $500,000. This makes the maximum valuation $2.5 million. Indeed, this method is a useful way to gauge value. Additionally, it is often utilized for tech startups. Consider using the Berkus Method to calculate the value of your potential startup business investments.
Cost-to-Duplicate Approach
When analyzing your potential investments, you can also use the cost-to-duplicate approach to value a startup business. The cost-to-duplicate approach is one valuation metric new businesses should follow. This involves accounting for all of the costs and expenses associated with the startup and product development stages. Notably, this includes the purchase of its physical assets. Then, these expense calculations are used to determine the startup’s fair market value. However, the cost-to-duplicate approach does not consider the company’s future potential by running projection statements. It also does not take its intangible assets into account. Therefore, it is important to consider the specific startup company before choosing a valuation method. Still, the cost-to-duplicate approach can be practical for your investment when thinking about the startup’s expenses.
Discounted Cash Flow Technique
Moreover, you can utilize the discounted cash flow technique when valuing a startup business for your investment. This can be functionally useful for IT, bio-tech, consumer products, and many other industries. First, you need to estimate the total market for the business’s products and services and its expected growth. Next, forecast the market share acquisition across a specific timeline. Finally, you need to forecast the cash flow. To do this, identify the startup’s fixed costs, variable costs, future working capital, and capital expenditure needs. With these projections, apply a discount rate according to the business’s lifecycle stage. Optimally, these calculations should be based on empirical data and account for risk. This technique can steer investment conversations toward true estimates that drive value.
Potential Exit Value Strategy
Furthermore, the potential exit value strategy can help you estimate your return on an investment in an early-stage company. You can base this value on either recent merger and acquisition (M&A) transactions in the sector or the valuation of similar public companies. Ideally, you should be looking for 10 to 20 times the return on your investment within two to five years for maximum profit. For example, assume an exit valuation of $100 million, and you own 20% of the company at the time of exit. Then, you would earn $20 million on your investment at the exit. If you invested $1 million, you would potentially make 20 times that on the exit. Of course, your valuation should include any purchased commercial real estate, the current inventory turnover and specialized intellectual property. You can use the potential exit value of a startup business to determine the price an investment must command when you exit or sell the company.
There are many different ways to calculate the startup valuation of a business for your investment deal. For example, you can you the market multiple method to give you a fair indication of what the market is willing to pay for the company. Alternatively, you could use the Berkus Method to analyze the critical factors of a business launch. The cost-to-duplicate approach is another valuable method you can use to assess startup costs and expenses. On the other hand, the discounted cash flow technique can help calculate the company’s projected earnings while still accounting for risk. Furthermore, the potential exit value strategy can help you calculate what you would need to invest to see a specific return when you exit a business. Consider these ways to calculate the startup valuation of a business for your potential investments.
