Valuation

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Measuring a Company's Potential

Stéphane Nasser, in his article 9 methods of startup valuation explained, describes a startup like a magic box.

Imagine the box having a value.

When you add more items to the box, the more it increases its value. Say, you thrown in a patent and a badass management team, its value just skyrockets.

Aside from that, it can also return your investment. For instance, when you put in a dollar, it can increase it by threefold or even tenfold.

However, building the magic box requires money.

You tell them, "You will get X percent of all the things that will come out of the magic box if you give me a million to build it."

Valuation of Startup Companies For startups, valuation is important because it helps them decide how much shares do they have to offer in exchange of investment. For instance, the larger the company is valued, the less shares and equity they need to offer to an investor or the more money they can receive as an investment. During the “seed stage,” the value of a company is close to zero. However, if you factor in growth potential, it will be higher.

Instagram's Valuation History

In March 2010, Kevin Systrom, founder of Instagram, raised $500k seed investment from venture capital firms while working on Burbn, a location-based app.

In October 2010, Instagram was launched and with the rapid user base growth, more and more investors became interested in funding the company. One of the investors was Benchmark Capital which gave Instagram a valuation of around $25 million.

Two years later, Instagram was valued at $500 million and in April that year, Facebook bought instagram for about $1 billion in cash and stock.

Stages of Startup Funding

Based on its name, the seed funding stage is where companies look for early financial support or “seeds” needed to grow their business.

Dana’s company is building a software which she thinks has great potential and market opportunity. She is about to make her first few hires of software engineers and her company valuation is at $93K. Her current investors are her family and friends. Is her company at the pre-seed or seed funding stage?

Once the startup company has developed a product or has a large customer base with stable revenue, it may seek Series A funding to further expand its customer base or product offers.

Series A potential investors are usually angel investors and traditional venture capital firms.

An IPO, which stands for Initial Public Offering, is when the shares of a company are sold on a public stock exchange, allowing anyone to invest in its business.

As we can see, valuation differs in each stage of funding. And while each funding stage operates in almost the same manner, valuation puts into perspective the different demands that investors make as a startup reaches its fruition, serving as a great barometer for evaluating their own entrepreneurial prospects.

Methods for Valuing Startups

In this lesson, we will talk about three most common valuation methods for pre-revenue startups.

Which is not part of the five elements in the Berkus Method?

Notice that each element weighs differently, giving more priority to certain areas, particularly on the strength of the management team (30%). What this method also does differently is that it compares similar startups (mostly companies in the same stage, location or segment) and find their average valuation. Once the total weighted factor of the criteria is determined, it is then multiplied by the average valuation of comparison startups. Let’s see how it's done.

Risk Factor Summation Method starts with the pre-money valuation of companies in the same region and then adjust it based on the assessment of those twelve risks. Investors need to either add $250K for a +1 point or deduct $250K for a -1 point. Let's see an example.