This guest post was written by Ron Flavin, Growth and Funding Strategist, Angel Investor, Author and Speaker at Ron Flavin, Inc., and previous Co-Director of the San Francisco Founder Institute - and was originally published on LinkedIn.
There are a variety of ways to value a startup a multitude of startup valuation models. Determining the pre- and post-investment of an early-or even mid-stage startup is a mixture of art, intuition and science. Startups are valued using any number of different startup valuation models, each of which may yield a different valuation for the same startup. If you’re an entrepreneur seeking funding, it’s important to know both how some of these valuation models work and what you can do to increase your startup's valuation.
Here are four of the more common startup valuation models that investors use, followed by some factors that could potentially increase the value of your startup both pre- and post-investment.
4 Common Startup Valuation Models
1. Market Comparables Method
The Market Comparables Method will be familiar to anyone who’s bought or sold a house, and real estate agents will be experts in it. This method uses comparable “sales” to determine how much a startup business is. Instead of looking at actual sales as is done in the housing market, the method looks at other successful funding rounds of similar businesses when valuing a startup.
In theory, the investors in a similar business that’s already raised funds knew what they were doing and provided an accurate valuation. If your business is like that one, your business’ value is probably comparable.
The Market Comparables Method might not always stand on its own, for investors will want to dive into the specifics of your business. It’s helpful for establishing a range and can be used as support for other valuations, however. The method is sometimes also known as the Market-Based Valuation, Comparables Approach, or Comparable Company Analysis (CCA) method.
2. Venture Capital Method
The Venture Capital Method looks at a startup’s valuation from the perspective of a venture capitalist -- and that’s a perspective that focuses on making money. Accordingly, the method is concerned with the expected return on investment at the time of exit. Exit is normally in three to eight years for most venture capital businesses, but there are exceptions.
When using the Venture Capital Method, there are two key terms to know. Terminal value is the anticipated value of a company at ext, when it’s sold. Return on investment (ROI) measures the expected return as a percent. The formula for ROI is: (terminal value) / (post-money valuation) = (ROI).
The Venture Capital Method is useful when evaluating how much money investors might make off of a business. It can be especially helpful when comparing different investment opportunities, and most VCs and angel investors have a minimum ROI that they seek.
3. Scorecard Valuation Method
The aptly named Scorecard Valuation Method uses a scorecard to value a business much in the same way that a judge might use a scorecard to evaluate an athlete’s performance. The method initially bases valuation on the value of a similar business, and then, it applies different weights to different categories. The methodology helps investors arrive at an overall valuation based on how they view the different strengths of a business.
The Scorecard Valuation Method is frequently used to value pre-revenue businesses that are seeking seed funding, and it offers a matrix through which valuation and seed capital can be discussed. The method is also known as the Bill Payne Method.
4. Risk Factor Summation Method
The Risk Factor Summation Method is similar to the Scorecard Valuation Method both in that the two are commonly used to value pre-revenue startups and both try to gauge how various aspects of a business impact valuation.
The Risk Factor Summation Method, however, focuses specifically on the various risks that can impact launch and growth. The method begins with a baseline valuation that’s obtained by averaging similar businesses' valuations, and then each risk is individually considered in turn. The presence of a risk reduces valuation, while the lack of a common risk can raise valuation.
Factors That Increase Your Startup’s Valuation
While these and other valuation methods that investors use to evaluate startups capture many aspects of a business, few (if any) capture all potential factors for all businesses. Specifically, intangible factors such as the following can often be used to increase a startup’s valuation:
- Intellectual property
- Business reputation
- Customer database
- Barriers to entry
If your business has any of these intangibles--or others--that could increase its overall valuation, make sure you know how to present those intangibles to investors for the best possible outcome, which is of course to increase the pre- and post-investment value of your startup.
Need Help Valuing and Presenting Your Business? If you are interested in learning more about how you can leverage intangible factors to increase the valuation of your startup? Contact me today, and let’s talk about valuation methods and intangibles that could help maximize the valuation of your startup.
This post was written by Ron Flavin (Growth and Funding Strategist, Angel Investor, Author and Speaker at Ron Flavin, Inc., and previous Co-Director of the San Francisco Founder Institute), and was originally published on LinkedIn.
Ron Flavin has worked with many founders to help get them in a strong position to launch startup funding rounds. Much of what he has learned about how to utilize intangible factors to increase startup valuation comes from colleague Stephen Brock, whose firm Medical Funding Professionals, helps firms in the BioTech, MedTech, Life Sciences and Pharma sectors to secure growth capital through Reg A+ funding, which is an often-overlooked fundraising raising strategy that allows firms to raise up to $75 million per year with less hassle and higher valuations, while also allowing founders to retain more equity.
Flavin is a growth and funding strategist who helps entrepreneurs and organizations to develop innovative growth strategies, identify new revenue sources or secure the funds they need to grow and prosper. Using his own unique methodology, he work with his clients to develop a step-by-step growth and funding action plan that builds a bridge between vision and financial goals. Using this model, he has obtained more than $200 million in funding for his clients, and been part of decision-making teams that have allocated more than $1 billion in funding. As a result, Ron knows first-hand what those who hold the purse strings look for when determining which proposals get funded and which ones get tossed aside.
Graduates of the Founder Institute are creating some of the world's fastest growing startups, having raised over $950M in funding, and building products people love across over 200 cities worldwide. See the most recent news from our Grads at FI.co/news, or learn more about their stories at FI.co/journey.