Building A Credible Valuation For Your Startup

Valuing your start-up accurately is crucial for attracting investors and securing their investment. A credible valuation demonstrates the potential of your business, while building trust and credibility.

Our friends at Focused For Business, who support startups in raising equity investment in 90 days, have a three-step approach to valuing a business which includes a theoretical valuation, a benchmarked valuation and a valuation grounded in the current economic climate. Here they explain the steps to ensure your valuation stands out to investors.

Step 1: Theoretical Valuation

The first thing to demonstrate is a theoretical valuation, which involves assessing your startup's potential value based on:

• Market Opportunity - a deep dive into the size of your target market, the growth potential, and the underlying trends. By understanding your market, you can better explain the potential to capture a meaningful share and generate sustainable revenue.
• Business Model - revenue streams, cost structures and the unique value proposition you offer to your customers. Articulate this clearly and you'll demonstrate not just the mechanics of your business model, but also how your startup generates and captures value.
• Competition - strengths and weaknesses of your direct and indirect competitors, their market share, and their unique selling propositions. By analysing these, you can demonstrate your startup's competitive advantages.

Common Valuation Methods for Startups

• Berkus Method: Particularly helpful for pre-revenue businesses, assigning value to the concept, prototype, and market acceptance, without the need to show revenues.
• Venture Capital Method: This method calculates the return on investment by estimating future value and working backwards. It involves determining the expected exit value and applying a target return rate to determine the current valuation.
• Scorecard Valuation Method: This approach evaluates factors like team, market, product, traction, and risk. It assigns scores to each factor to arrive at a valuation.
• Discounted Cash Flow (DCF): This approach is most suited to businesses with stable and predictable revenues, because DCF calculates the present value of future cash flows. It's less appropriate for pre-revenue startups.

If you are looking to get started with a valuation for your business, why not answer 10 quick questions to get an indicative business' valuation, using Focused For Business' Valuation Calculator.

Step 2: Benchmark Valuation

Having considered your theoretical valuation, the next step is to check that your valuation is in line with other valuations within your sector and for businesses at a similar stage. A Benchmark Valuation compares your startup to similar companies based on available data.

Identifying the Different Factors to Benchmark:

• Industry Comparables: Find startups and companies with similar business models and then assess their market position, revenue models and growth trajectories to find a baseline for comparison.
• Recent Transactions: By looking at valuations from recent funding rounds or acquisitions you can then assess whether your valuation is in the right ballpark or, if you are an outlier, how you would justify this. Platforms like Scribe can help.
• Public Market Comparables: Where companies are publicly listed, it may be easier to find benchmark data and to calculate multiples (see below), because public companies have more comprehensive financial disclosures.

Methods for Conducting a Benchmark Valuation:

• Comparable Company Analysis: This involves identifying similar companies and applying their valuation multiples (which are tracked, published and widely available) to your financial forecast. For example, if a comparable company is valued at 5x its revenue, apply this multiple to your startup's forecast revenue to estimate your value.
• Precedent Transactions Analysis: This uses past transactions (funding rounds, mergers or acquisitions) of similar companies and applies their multiple to your business. This involves looking at acquisition prices and funding round valuations of companies in your sector and stage.

Challenges and Considerations:

• Adjustments for Differences: When using comparable analysis, it is important to compare appropriately so you need to make adjustments for differences between your comparable company and your own startup. Factors like market size, growth rates, and operational efficiency can vary and must be accounted for in your valuation. This is not always easy!
• Keeping Benchmarks Up-to-Date: Market conditions can change rapidly, so it's important to keep your benchmarks current. Regularly update your data to reflect the latest trends and transactions.
• Limited Data Availability: Some sectors might have limited data available for comparison. In such cases, consider using a combination of theoretical valuation methods and whatever data you can gather.

Using a tool like Focused For Business' Benchmark Assessment helps overcome some of these issues, saving you time and money

Step 3: Valuation Grounded in the Current Economic Climate

The current economic climate significantly impacts startup valuations. Factors such as market trends, interest rates, and investor sentiment can all influence your startup's value over time.

What Factors Can Influence the Economic Climate and your Valuation?

• Market Trends: The market can be affected by changing trends, such as technological changes, regulatory shifts and changes in consumer behaviour. For instance, a surge in demand for remote work technologies during the COVID-19 pandemic increased valuations in that sector.
• Interest Rates: Higher interest rates mean the cost of capital is greater, typically leading to lower valuations. Conversely, lower interest rates can result in higher valuations due to cheaper borrowing costs.
• Investor Sentiment: Investor confidence - in markets and sectors - also has its effects. Bull markets often result in higher valuations, while bear markets tend to lower valuations.

It isn't always easy to know how to interpret these trends. On Focused For Business' Funding Accelerator programme startups gain free access to a specialist database that makes it easy to see how valuations are changing over time. This gives them the evidence they need to explain why their valuation is appropriate to the current economic climate when talking to investors.

Using your valuation to secure investment

Building a credible valuation for your startup is a multi-faceted, multi-staged process. By following the approach outlined here, you build up the evidence needed to justify a valuation over three steps. This gives you confidence in what you are doing, helps you explain your thought process to investors and ensures your valuation is robust and appealing to potential investors.

If you're looking for help refining your valuation, a good place to start is at one of Focused For Business's free Funding Strategy Workshops.

Scribe is a private company data platform. We structure data from Companies House, helping Founders find Angels who are actually investing. Welcome to the future of company knowledge.