Startup Valuation: Why it matters & How to calculate it

Valuation matters to entrepreneurs since it decides the share of the company they need to offer away to an investor in return for cash. At the early stage the estimation of the company is near zero, however the valuation must be a considerable measure higher than that. Why? Suppose you are searching for a seed investment of around $200,000 in return for around 15% of your company. Run of the mill bargain. Your pre-cash valuation will be $3 million. This does not imply that your company is worth $3 million at this point. You most likely couldn't offer it for that sum. Valuation at the early stages is a great deal about the growth potential, instead of the present quality.

Without years of financial data to depend on, new companies and their investors have needed to depend on more imaginative approaches to substitute for these inputs. More or less, the process goes back to measuring a touch of fundamental finance: risk versus reward. In startup phrasing, it's traction versus market size.

What convinces the investor?

The greatest determinant of your startup's valuation are the market powers of the business and sector in which it plays, which incorporates the parity (or irregularity) between demand and supply of money, the recency and size of recent exits, the eagerness for an investor to pay a premium to get into an arrangement, and the level of desperation of an entrepreneur looking for funds. Let’s break it down in two main points:

Traction: Everything that you could demonstrate an investor, traction is the main thing that will persuade them. The purpose of a company's presence is to get clients, and if the investor sees clients – getting funds as easy as buying a candy. Things being what they are, how many clients? In the event that every single other thing are not going to support you, but rather you have 100,000 users, you have a decent shot at raising $1 million.

Revenue: Revenues are more imperative for the B-to-B startups than consumer startups. Revenues make the organization simpler to value. For consumer startups having revenue may bring down the valuation, regardless of the fact that they’re for a short time. There is a justifiable reason behind it. In the event that you are charging clients, you are going to become slower. Moderate development implies less cash over a more extended timeframe. Lower valuation. This may appear to be nonsensical on the grounds that the presence of revenue means the startup is nearer to really profiting. Be that as it may, startups are not just about profiting, it is about developing quick while profiting. On the off chance that the development is not quick, then we are taking a gander at a customary cash making business.

How to Calculate Valuation of an early stage startup?

You have to put on the cap of your investor in setting valuation to get them amped up for your startup versus several different startups they see every year.
Investors are searching for that next 10x return opportunity, so ensure your five year estimated financials will develop sufficiently substantial in that time period to give them a 10x return.

Start with making a list of your assets like Software or Product, Cash Flow, Customers/Users Partnerships etc.

Choose a method

· Berkus Method: To start with, Berkus says that financial analysts ought to trust that the company can possibly hit $20 million or more in revenues by the fifth year of operation. At that point, he applies a scale to five parts of a startup, rating each at up to $500,000.

1. Sound Idea
2. Prototype
3. Quality Management Team
4. Strategic relationships
5. Product Rollout or Sales

Since you’re pre-revenue, the fifth component doesn't matter. Subsequently, the greatest value of your organization using this process is $2 million.

· The Risk Factor Summation Method: The Risk Factor Summation Method considers a much more extensive arrangement of components in deciding the pre-money valuation of pre-revenue startups. This technique might be less helpful as a stand-alone valuation strategy for investors, yet I believe that this strategy is ought to be one of a few strategies utilized by early stage investors to set up pre-money valuation, since it strengths investors to consider external components. While this technique surely considers the level of management risk, it likewise prompts the client to survey other risk sorts, including:

1. Management
2. Stage of the business
3. Legislation/Political risk
4. Manufacturing risk
5. Sales and marketing risk
6. Funding/capital raising risk
7. Competition risk
8. Technology risk
9. Litigation risk
10. International risk
11. Reputation risk
12. Potential lucrative exit

Each risk is assessed, as follows:
++: + $500,000
+: + $250,000
0: 0
- : -$250,000
--: -$500,000

Let’s say the pre-money valuation of your company is $2 million. After calculations if you get 4 +, one –, one - -2 and six 0s. Add $250,000 to your pre-valuation.
Again, there are many methods to valuate an early stage startup. These methods are more theoretical and call for every external and internal factor.

Much like craftsmen, entrepreneurs need to use imagination in valuing their startup. Customary ways to deal with valuation taking into account book values and P/E ratios are likened to painting by numbers. In the event that you need your startup to be a showstopper, you'll have to utilize the right half of your mind as much as your left to decide value.