Company Valuation Methods
Most founders and investors know when they have the next big thing, but how does that knowledge transfer to an actual valuation? Startups are difficult to value because most of these companies haven’t reached their full potential or even made their first sale yet.
Both investors and founders are always trying to find the most favorable valuation method to maximize capital-raising activities and a return on investment. This results in a plethora of different methods to choose from, making it vital to understand the basics of each to select the right one for your startup.
What are the Different Valuation Methods?
Each valuation method takes different factors into consideration; however, there are a handful of common ones that you might encounter, including:
· Book Value Method - This valuation method works based on your company’s net worth. This takes total equity and divides it by the outstanding shares. This method is frequently referred to as an asset-based valuation.
· Comparable Transaction Method - The Comparable Transaction method takes recent startup sales in the same industry to derive at a valuation. By looking at similar sales, you can benchmark where your business’s valuation will fall.
· Berkus Method - This method is fairly common for startups that haven’t generated any revenue yet. The measurements are based on the value of technology, execution, strategic relationships, and production.
· Discounted Cash Flow Method - This method relies on predictions about future growth and profits. Startups that recently launched frequently use this method since it projects what a startup could make by using the investment return rate.
· First Chicago Method -The First Chicago method takes into consideration different outcomes that can affect the valuation, presenting a worst-case and a best-case scenario. This allows investors and founders to look at the different growth possibilities.
· Scorecard Valuation Method - This method compares the startup with others in the same industry and includes analyzing the strengths of the management team. Each category is assigned a comparison percentage that is used to value the company.
How to Choose the Right One
Choosing the right valuation method is critical as each computation will result in a different figure. A higher valuation is generally better as it gives you access to expanding capital raising activities and boosts investor confidence. Nevertheless, some investors may prefer a specific method, especially if they are investing under a company name.
You will need to analyze the characteristics of your company, the characteristics of the investor, and the purpose of the valuation to find the right one. For example, if there are little to no startups in your same industry, the Comparable Transaction method might not be the best fit.
Many people don’t care about doing the right thing; they only care about what benefits them the most. A consultant has your best interest in mind, meaning they can provide you with an unbiased opinion. This is critical to the success of your business, as consultants aren’t emotionally invested in the outcome. An impartial view is essential in family business because family dynamics can lead to difficulty selecting the best option.
IN SUMMARY:
Choosing the right valuation method to present to investors takes careful consideration, which often includes calculating multiple methods to determine where the numbers fall. Going through these computations on your own can be tricky and opens the door to error. This is when bringing in an experienced consultant is beneficial. Divocate Consulting knows the different impact each valuation method has on your business, giving us the competitive edge you need to maximize your capital-raising potential. Reach out today for more information.
