Businesses are valued based a multiple of earnings and profit. The variation stems from a few things associated with what that multiple might be (since earnings and profit are evident)
- Investor opinion about the capabilities of the executive team
- Investor awareness of competition, threats, and opportunities
- Investor knowledge about the market, trends, and potential regulation
- Investor insider knowledge (don’t doubt that *insider* trading doesn’t happen, it may not be ethical or even legal, but people absolutely make decisions based on things to which they’re privy)
Hopefully you can see how established company financials might determine you are a $10MM company but when we then set a valuation for the sake of investment, which is based on FUTURE potential, we’re adding what we think that future holds.
Based on considerations such as these, I might feel comfortable that your business is worth 4x that while another investor might have concerns or lack information that has their assessment at 3x.
Startups don’t work at all the same way because startups, by definition, don’t have a clear business model, can’t genuinely use whatever earnings might exist as a valid predictor, and shouldn’t be profiting (since they should be reinvesting their own revenue before taking on your capital).
So, by what measure do we assess??
In reality, and don’t let any investor tell you otherwise because frankly, they’re telling you what you want to hear or what they want you to hear, it’s wildly inaccurate. There is NO certain way of accurately valuing a startup.
One thing we advise founders to NEVER do, when fundraising or talking to investors, is state what they think is their valuation. Because trust me, if experienced investors, banks, advisors, and incubators can’t do it, how the hell could you, just because you work the startup??
The fact is a startup is a temporary venture in search of a business model — you don’t have relevant earnings, you have no model you can follow to forecast earnings, and you have no consistent costs by which to even consider some sort of profit.
Businesses do! “Startups” don’t — that’s what a startup is.
So, if an investor expects you to state or be able to determine your valuation, or you set a number, you are both WRONG (and the investor is being an ass).
If you’re a business, you’d better be able to do it! But as a startup?? The appropriate answer to anyone asking for your valuation, pre-funding, is, “how would I know that? If you’ve figured out the mystic science of determining the value for a startup, please, tell us what it is and fund us relative to that.”
Read that reply again because it might sound snarky, and I mean it to be, because if an investor *knows* your valuation, they would fund you.
They would fund you because they could be certain that that’s what you’re worth, which is dependent on what you will be worth… therefore they can offer terms and a check because they’ll want a piece of that.
So put it back on them.
This is why if they ask or expect, they’re being an ass (or they’re an idiot).
When fundraising, investors set the terms. They determine the value with which they’re comfortable! You sit quietly and answer questions to help them work out what works for them; you don’t worry about your valuation AT ALL.
And yet still, we have this question, how is it valued??? And indeed, as a founder, you do want to have an assessment so that you can choose to be comfortable with what an investor offers (or so that you can say no to them).
In startups, valuation is loosely based on:
- What would it cost for other developers to build the same thing? Careful now, this can be disappointing. I know it took you years and scraping by to get your app built, but if another developer can now look at that and build it for $10,000, it’s worth $10,000
- Founder experience. Is it relevant? Is it extensive? How big is their network? History of previous success or failure? All of that is valuable (yes, even previous failure is valuable).
- Did you know that the average age of a successful founder is 46? Yep, older. Pop culture, local meetups, and media, make us tend to think startups are successful for younger people, they’re not, its 46 years old. So, like it or not, sure, call it ageism, the fact is, 25 years after college is a lot of experience — and that’s valuable.
- Market rate salaries of the team. This is a fudgy and loose consideration, but it makes sense to factor it. If you have a team of 5 people and you’re all working for equity (no compensation) then arguably, you’re doing about $700,000 worth of work every year. That’s value. You won’t get paid that much as a startup, even when you are paying yourselves, you get paid less than market, but you can see how that’s a way to assess the value of the startup: you’re a team of people worth something.
- Comparables. The notion that you don’t have competition is ignorant (hopefully you know that) which means that there are other companies to consider. There are established similar companies worth a lot but not innovative. There are maybe other startups that have been funded. How that all shakes out is valid.
- Let me give you an extreme example. Companies in HealthTech — if Bio, Pharma, or some MedTech, these kinds of companies require a lot of development to overcome regulation and the market, they tend to raise a lot more money, and therefore, an early valuation in the many millions is not unreasonable. That said, if what you’re doing is a mobile app to manage medical records and communications with doctors (also HealthTech), you can see how that couldn’t be valued as greatly (yet) because we know from comparables that it doesn’t cost a lot to build and bring such a thing to market.
- Extreme examples that hopefully show how if you claimed or an investor thought you were valued far LESS (or more) than typical, we have a red flag.
Make some sense? Can you see how we can’t KNOW the valuation of an unfunded startup. No one knows.
We have an assessment, and then investors (as they do with businesses) factor in a multiple which is similarly dependent on my bullet points for businesses — that, with only an assessment, are you then a multiple of 7x or 15x? That’s up to what people think — not what you say, or math proves.
Footnote: do notice that I used *unfunded* a couple of times in the context of my perspective about startups. That’s because once you are funded, a valuation is clearer because that value has once already been established — a valuation was established when you were funded. What are you worth now? Same fudgy calculation but it’s based now on an existing established value.
This is why as a pre-funded startup, the only valid answer to your valuation is “it depends” while we can sort of arrive at a reasonable range, not an actual valuation.
Reach out if I can help