How to Value My Startup At The Early Stage?
While the valuation of established companies, regardless of their size, is more straightforward, valuation of your startup does not have a straightforward method. The following is a brief in response to the inquiries we have received from startups who asked about the valuation of their startup at the early stage. (Note: at the early stage you will be dealing with angel investors than VCs.)
Before we discuss the valuation methods we need to clear the “early stage”. By early stage, we mean a startup that the team has put the effort to do a thorough market study, and has made an MVP that has impressed the clients to some degree. The startup may have some revenue or not. But funding is required to expand the team, to complete the MVP with more features, and engage to the market.
Method 1: Market benchmark
Recent transactions in the same market sector (or similar niches) can be used as a guideline for valuation of your startup. For example, if an investor has invested $100,000 in a similar startup to yours for 25% stake, then you could assume that the valuation of your rival (hence yours) is about $400,000.
Collect as much information you can about the recent transactions in your niche. Develop a comparison table to compare your startup with the one recently had a transaction. Develop a list for your investor as why your team, product, approach, marketing strategy, etc. is comparable (or even superior) to your rival, and why your startup should be valued the same (or even higher).
Method 2: Multiples
Revenue or EBITDA multiples is often being used to determine the value of startups at the early stage. First, you need to understand your niche multipliers. Let’s say you are in the mobility sector of Iran, and market insight indicates that one of the players is making 170,000 trips per day, at 15,000 Tooman per trip and 10% commission, which is 23.3 million dollars gross revenue per year. The company would have about $11.6 million gross profit (at 50% operations cost), and $8.7 million EBITDA (at 25% G&A). Based on the recent transaction we conclude that the startup is valued at about $80 million dollars. In the other words, the niche has a gross revue multiplier of X3.4 and EBITDA multiplier of X9.
You could use your niche multipliers to your startup; here is how… first, you need to estimate your total available market (TAM), then the serviceable available market (or SAM). As a dominant player, you might target 70% of the SAM and call it your target market (TM). Let’s say your SAM is about $8.3 million per year and you aim for 70% of this market in year 4 which will be about $5.8 million per year. In a reverse calculation, the value of your company in year 4 would be $5.8 million times 3.4, or $19.5 million.
But what does your startup value at the early stage? Most of the investors expect to see their investment to grow 10 to 15 times at the exit in year 4 or 5. So if they accept all your assumptions and calculations so far the value of your startup would be about $1.9 million ($19.5 million divided by 10). Taking 15 for one time dilution of their investment would give a lower range of $1.3 million. So you could discuss $1.3 to $1.9 million range as your valuation to the investor. Please see other influencing factors at the bottom of this post.
Method 3: Discounted Cashflow
This method uses your financial plan to calculate the net present value of your company at the exit, say year 4. A discount factor used for calculating the NPV should be much higher than the banks’ interest rate, even higher than private lending in your local market. For example, in emerging markets banks offer secured loans at 20% annual interest rate. Considering political risk, inflation and high risk of startups, you may consider 40% to even 50% for your NPV calculations. The valuation in this method should be close to your valuation in other methods.
Other factors that can influence (positive and negative way) the above numerical methods are:
The team – I personally believe that more than 75% of the investment at the early stage is in the team. The founder, synergy, teamwork, values, dialogues, and communication of the team tell a lot to a sophisticated investor. In today’s market, ideas have a short life cycle. It takes a creative team to build unique products and excel in the competition. Please see here on the team and pitch deck.
Society, country – Valuation of the very same startup in India would be different than the one in Iran, or France. Your startups will be adding the same value in the same form to its audience, but external factors such as regulatory and policy, market dynamics, culture,… could elevate or reduce the chance of success of your startup, hence the valuation of it, and the risk of investing in it.
The sector and the niche – The numeric methods discussed above can have a niche-multiplier. The multiplier would be higher for niches such as fintech that might have a lower cost of customer acquisition or higher life-cycle revenue per customer versus a niche that is less developed and requires a higher cost of customer acquisition or higher cost or longer time of market development.
Rivals and the market maturity – Your startup will be competing with rivals. Presence of rivals in a niche often help to develop the market and to expand the pie. However, the presence of well-established rivals would erode chance of your success; hence valuation of your startup. In the same way, unless you introduce a game-changer (e.g. product diversification, micro-niche, etc.) introducing the same product in a mature market would be less attractive to investors.
Timing and the match – Your startup is unique in many ways. It is not merchandise like a pair of jeans that can fit many. There is one investor that connects with your startup the best and is willing to invest the right amount. Often angel investors (and even VCs) have a niche specialty. Some rather invest in e-retails than mobility; others are specialized in fintech. You should be prepared to spend 3 to 6 month to find that investor. Be patient and show your deck to all potential investors. Some founders present their decks to more than 100 investors until they find the one.
The above provides a guideline in the valuation of your startup at the early stage. Smart teams look for more than capital in their investor. Often the capital is not the only thing that your startup needs to leave your competitors behind and keep the blue ocean ahead blue. Look for business experience in your angel investor, specially in strategy, business development, and marketing. See what network and industry background he or she can bring in. See what competitive advantage can your angel bring into your startup.
Please share your questions about valuation of your startup below, or contact us at info@TuneupVentures.com
A community builder, facilitator, startup mentor and angel investor. Koorosh has inspired and built teams in Canada and the UK as well as several emerging markets. He consults with VCs, funds, angel groups and startups on funding, financial planning, deal structuring, niche validation, pivoting, and go-to-market strategy.