Startup valuations can be a tricky business. Just take a look at Flow, a real estate company that's still in its early stages. Despite not even being built yet, it was valued by investors at over $1B - and the founder, Adam Neumann, is far from an upstanding citizen.
WeWork, Neumann's previous venture, provides a perfect example of this. The company was highly valued during its early years, but rapidly lost its shine as Neumann's questionable business practices came to light.
So what exactly goes into deciding a startup's value? And why do some companies seem to get away with more than others? In this article, we'll take a closer look at startup valuations and try to answer some of these questions.
What are Startup Valuations?
Startup valuations, or simply referred to as valuation, differ wildly from one startup company to the next.
The rules of the game for raising VC funding is sufficiently narrow as to where startup valuations should be within certain ranges. Startups then start ups have varying degrees of difficulty in attracting return backers.
Startups can determine their own valuation and in some cases, large companies use the exit market to obtain revenue or a valuation.
Through the help of a valuation, you're able to assess your startup for future funding decisions but there are many variables surrounding startup valuations.
Because the markets and economies within which startups operate are unpredictable and the pricing and returns for the particular issues at hand also unpredictable, startups valuations even more fickle. Instead of predict the future or the outcomes of trading stock on a stock market, startups valuation is used to predict the minimum size of the investment required from shareholders.
This depends on where the startup company is being deployed. A San Francisco backed, tech startup valuation would differ from that of a Valley-based startup.
Why Startup Valuations Matter?
Traditionally, annual salaries have been used to figure out what a company's value really is. Suppose you're drafting a valuation document. First:
- - Think about what a salary figure of $50k/year means to you.
- - What would the worst-case scenario be if you busted your butt for 16 years for this amount?
If you managed to only take 6 sick days a year, it'd burn you around $1,200. If you worked in administrative support or sales for the entire time - let's say it took you 5 years. It's more than 20,000 hours - $115,000! "Annual salary" is the conservative base salary benchmark: the most you'll ever earn as an employee before the company will have to pay taxes on it.
In reality, most businesses pay less than average for their employees. Some even pay a negative number, which is common when companies are so small. Companies that take a conservative approach fail to see their entrepreneurial or business potential. Take WeWork, for example. Didn't they know a very attractive-sounding $5.
What Are the Details of Startup Valuations?
Here are some of the crucial terms in startup valuations:
• A valuation is a figure used to determine the estimated monetary value of the startup as an entity. It's referred to as a "valuation," not a "Valuation."
• Startup Law: The law governing the taxation of many startup businesses calls for startups to be taxed when they generate revenue. Right now, startups are only taxed when they exceed $25,000 in revenue.
• Base amount: There are multiple types of bases used when calculating the value of a startup as an entity. Some include only tangible assets, other include both tangible and intangible assets.
• Fringe benefits: In addition to calculating revenue, the base, and providing services and goods, startups also need to write off certain business expenses.
• Discount for cash flow: Another way to reduce the value of a startup, especially for early-stage startups, is by taking a discount for the future operating profits. This is because a startup has yet to show consistent earnings.
Types of Valuations of Startups
There are a number of different types of valuations that a startup can undergo. These include:
- Initial public offering (IPO): A company goes public by selling shares to the general public, typically through an exchange. This is the most common type of valuation, and it allows startups access to capital from other investors who may have more experience and expertise in the industry.
- Venture round: A venture fund invests money in a startup, usually in return for equity or convertible debt securities (i.e., notes that can be converted into equity at some point in the future). This type of funding gives startups access to funds they wouldn't otherwise be able to get, as well as guidance and support from their investment team.
- Debt financing: Some startups opt for debt financing instead of raising additional capital through an IPO or venture round. This option enables them to receive funding quickly without having to go through a lengthy process like submitting SEC documents or going on multiple roadshows targeting potential investors."
General Suggestions for Startup Valuations
Let's tackle the components of a startup valuation, gradually stripping away the decision-making factors that you may not be aware of. Here, we're going to start with the initial compilation of data you need to decide on your product's value and encapsulate business development.
1. Current market valuation, so in order to achieve what you are looking for you have to value it according to its current valuation
2. Product definition, which means how much you'd expect to sell it for.
3. Projected app store revenues, as this helps you figure out how much you have to sell it at in order to be able to achieve the valuation you are looking for.
4. Customer development in, you also have to look at whether you are selling into a previously non-existent market or a year of sales.
5. Customer base, of course, you need to know what percentage of your target group you need to sell your product to be worth it.
6. Marketing budget, in which you calculate how much you have to spend in order to be able to bring your startup to a larger audience.
7. Returns on invested (ROI) marketing budget, which is the ratio of the return the marketing activity derived by the amount invested on it.
What Other Startup Valuations to Prevent?
A great first step if you aspire to become an entrepreneur is to learn to read the right startup valuations. You need to compare valuations and opportunities accurately and have the ability to differentiate reputable investors from malicious ones.
Take for example, Flow, a realtor firm that's still in its earliest stages. Nevertheless, the company was given a valuation of big bucks, surpassing the whopping $1 billion mark. According to sources fighting for $1 billion startup valuations suggests that the rules apply to startups that could threaten incumbents and provide comparatively little strategic advantage.
Moreover, Nielsen, in an interview with The Wall Street Journal pointed out that the subjects of these valuations tend to be "very particular and very true to their start-up stories" in terms of "stock and relationships with specific investors and companies", which tends to make their startup valuations more believable, and seemingly less so Fake A-V-e-r-s.
To learn about more BVC mistakes they make concerning startup valuations, go to StartupVentureCapitalMistakes.com
Read the full article to find out what startup valuations are, and when it is relevant to do so.