I am frequently asked by founders during my talks and
conference participations how do I value a startup.
The first method is really an art more than a science. We
know what market pre-money valuations are currently prevailing.
But more
importantly, we figure out that pre-money number from a founder's ownership for
the series A, but also subsequent rounds of B and C. The rule of thumb is that
if a startup is raising $1.5M then the pre-money is going to be around $1.2M to
$1.5M, netting the founders a 50% ownership stake on a post-money basis. The
goal is for the founders, if they execute well is for them to reach an enhanced
valuation by the B and C rounds, and be diluted to 25% post B-round and to
10-15% post-C when the startup would have reached run-rate revenues to be able
to value it for an M&A transaction through some of the more classical methods
below.
Forward revenue multiples
are beneficial methods for founders and for venture capitalists. There
are two basic revenue multiples that every single investor needs to be made
conscious of. The 1st, and most well-known, is Price to Sales or just P/S. The
next and the more solid metric of the two is the Enterprise Value to Sales or EV/S
(Equity + Debt - Cash; and in most VC cases Equity-Cash, since there is rarely
any debt).
Enterprise Value to
Sales Ratio (EV/S)
Venture capitalists use estimations like the EV/S multiple to
find a business's value. It is measured by adding its market capitalization to
its debt, minority interest and preferred equity then subtracting its liquid
assets. The result is a multiple that gives valuable understanding for investors.
For instance, a corporation with a revenue multiple of 1.9x effectively means
that other investors might be willing to pay $1.90 for every $1 of revenue
produced by the corporation.
Pre-Money Valuation
Investors and the businesses might have significantly
diverse views of the business’s value. Investors like low figures, so they can
get a good deal. Alternatively, businesses want them excessive, so they can get
additional investment money. Pre-money assessment is the agreed-upon price
before any dollar is invested. Furthermore, potential buyers may possibly use a
multiple of the current revenue to value the company, if the company is
presently making revenue.
Post-Money Valuation
Revenue multiples can have far-reaching repercussions. Poor
multiples will turn-off numerous investors. Powerful multiples enable the
company to keep more equity of the business, soon after the investment is
created. Venture capital equity is determined by using the capital
investment figure “I” and dividing it by the pre-money value “V” and then added
in to the capital investment “I” (I/V+I). Thus, a strong multiple will maximize
the pre-money valuation amount.
Future Value
Start-up businesses rely intensely on forecasts. Most
start-up businesses, by description, are not proven and commonly have poor
sales revenue. Estimations like, revenue multiples guide to project possible
larger income in upcoming days -- generally about three to five years -- to
convince venture capitalists for a good investment.
A revenue multiple may be more beneficial at times
comparatively to the commonly used price-to-earnings ratio, in stock
assessment. Specific restrictions exist when utilizing the P/E ratio, which
could make the P/E ratio less purposeful. On the other hand, revenue multiples
are much more appropriate even in some unique business and earnings scenarios
for venture
capitalists.
