Key takeaways
You have a great idea, perhaps a brilliant one. You may have the beginnings of a prototype and perhaps a partner in crime or two. You’re officially an entrepreneur at the helm of a company. But what is a startup valuation? Answering that question can be difficult. It involves calculating a startup's worth based on various factors, including market conditions, financial projections and comparable companies. An exact value may ultimately depend on what potential investors think. But the investors and entrepreneurs below offer useful yardsticks that can help you put a dollar figure on your fledgling startup.
Setting the valuation for an established startup is relatively straightforward, even if it can spark arguments and disagreements. At least there’s revenue, cash flow, growth rates and other financial metrics to help decide its paper worth.
To determine a startup's valuation, you can use methods like comparable company analysis, the cost-to-duplicate approach and the discounted cash flow method. Each method offers a different perspective on what the startup is worth, depending on available data and market conditions.
Key performance indicators (KPIs) are crucial in these valuation methods:
What if a young tech company has little or no revenue and maybe not even a prototype? How do you calculate seed evolution? In the seed stage, valuations are typically based on factors such as the team’s experience, the market potential and any initial traction the company may have rather than concrete financial metrics. “At the very earliest stage of any new venture, it’s all about hope and not metrics,” says Jason Mendelson, a founding partner at the Foundry Group, a venture firm based in Boulder, Colorado.
What is an example of a startup evaluation? For instance, if a startup is seeking $1 million in funding and offers a 20% equity stake, it implies a post-money valuation of $5 million. How does a founder — or investor — put a value on that hope and potential? The answer is to start with a comparable company analysis.
A comparable company analysis borrows from the real estate playbook when the value of a home is determined by looking at “comps,” or comparable homes. In venture capital, this involves comparing your startup to similar companies in the industry that have recently received funding or been acquired. Mendelson recommends establishing a startup’s valuation that is “on scale” with those of other early-stage companies. The more similar the startup — be it its sector, location or potential market size — the better.
Even so, not all startups that are little more than a few engineers working on an idea sketched out in a PowerPoint slide deck are the same. “We laugh at [venture] firms that use spreadsheets for seed and Series A deals for valuations,” says Mendelson, co-author with his long-time partner, Brad Feld, of the book, Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist. “There’s just not enough data.”