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How Does Startup Valuation Work?

How Does Startup Valuation Work?

Learn some basic methods of valuing your startup (a.k.a ‘startup valuation) so that you can estimate your business’s worth.

17th January 2018

Are you considering selling your startup or looking to raise business capital from investors? Or do you simply want to find out how well your startup business is doing?

Startup valuation is the process of determining roughly how much your business is worth. While a startup valuation is only a formalised guestimate, it is still very useful for informing your business decision-making.

There are many different methods of startup valuation. There is no one set method, and a combination of methods can be used depending on your circumstances. Below are some common methods which you can start with before you consult a professional or engage in more advanced calculations yourself. It is always recommended to get in touch with a startup lawyer to provide expert legal guidance every step of the way.

Is my startup doing well?

1. BERKUS METHOD

Explanation: This method provides you a nice framework to assess how much your startup is worth and more importantly, what you should improve.

Method:

  • Step 1: Evaluate your startup against these 5 criteria points: sound idea, technology, quality management team, strategic relationships, sales.
  • Step 2: For ‘Sound Idea’, credit your startup with a value of $500,000. This is the default (basic) value.
  • Step 3: For the other four criteria points, credit your startup in each of these areas with an appropriate value up to $500,000.
  • Step 4: Add up all five values from step 2 and 3 to obtain the initial value of your startup. Note the initial value is capped at $2.5m (perfect score of $500,000 x 5).

Is my startup ready for sale?

2. BOOK VALUE METHOD

Explanation: This calculation will produce the net worth of your business. When calculating total assets, ensure that you include both tangible (such as equipment, inventory and stock) and intangible assets (such as intellectual property, brands and goodwill) of your business.

The book value is useful for determining the sale price of your business

An accounting balance sheet is a useful tool for this method. For more information on how to create a balance sheet can be found through business portal.

Method: Total assets minus total liabilities

3.ESTIMATE FUTURE PROFITS METHOD

Explanation: Information about the profitability of your business gives a prospective buyer an idea of the expected returns in the future. A profitable business also gives you leverage to sell your business at a higher selling price.

Financial statements are a good basis for this calculation.

Method: Examine trends in your business finances from past years. Positive trends indicate strong profitability (and vice versa).

Is my startup ready for investment?

4.RETURN ON INVESTMENT METHOD

Explanation:This method uses your business’ net profit to determine the value of your business. It is particularly useful for potential investors as they can estimate the rate of return (expressed as a percentage) if they choose to invest in your business.

For a simple example of this method, check out the business portal

Method:(net annual profit/ selling price) x 100

5.RISK FACTOR SUMMATION METHOD

Explanation: This method may inform the potential investor of what your business could be worth if all relevant risks materialize. The exercise also allows you to evaluate the strengths and weaknesses of your business from a quantitative and qualitative perspective.

Method:

  • Step 1: Evaluate your business against these 12 criteria points: Management, stage of the business, legislation/political risk, manufacturing risk, sales and marketing risk, funding/capital risk, competition risk, technology risk, litigation risk, international risk, reputation risk, potential lucrative exit.
  • Step 2: For each criterion point, give your business a score of +2 (very good), +1 (good), 0 (neutral), -1 (bad) or -2 (very bad).
  • Step 3: Calculate the initial value of your business using the Berkus Method (see above).
  • Step 4: Add up all the scores from step 2, and multiple the total score by $250,000.
  • Step 5: Add the outcome in step 3 to your initial value (from step 4).
  • Step 6: Your final value will roughly represent the pre-money value of your business, taking into account all relevant risks.

CONCLUSION

There are just a few of the many startup valuation methods that exist today. The most suitable method depends on whether you want to sell your startup, offer it for investment or check its financial health. If you require assistance valuing your startup, connect with a startup lawyer today.

Still unsure of how to value your startup? Contact a LawPath consultant on 1800 529 728 to learn more about customising legal documents, obtaining fixed-fee quote from Australia’s largest legal marketplace or to get answers to your legal questions.

Author
Ray Sun

Ray is a Legal Intern at Lawpath working with the content team. With an interest in Legal Technology, Contract Law and Equity, Ray is currently completing Bachelor of Laws at the University of Technology Sydney.