Company valuations are a subjective science. The person engaging in the valuation determines the best way to see how much the business is worth. Understanding the value of a startup investment is tricky. The procedure of valuation is usually used to assess how much the business is worth so that it can be sold. It’s hard to assess the value of a business in its early years, especially when it is still setting its course.
How Company Valuations Are Calculated
An investor can play it safe when conducting a company valuation by classifying a startup as an existing or new type of business. An existing type of business is comparatively simple to value. The investor has a choice of estimating one or more of the following: the company’s assets, the company’s earning potential (income), or the company’s potential value in a future sale (market).
It is trickier to estimate a new type of business. Investors have to analyze the potential need or desire for the company’s service or products. They also have to analyze what type of partnerships the company can create. In addition, investors have to review a new company’s business plan and determine whether that plan will be effective.
For an existing type of business, an investor can hire a chartered business evaluator (CBV) or an accountant to calculate the worth of the company. If certain facts and numbers are known, like the level of financial risk, an investor can use an online calculator to determine the worth of a business. For a new type of business, the person interested in the value should work with an individual familiar with the earning potential of the startup investment. There are many formulas to assist with calculation. These include use of a profit multiplier, looking at a comparable business that was sold recently (comparables) and asset valuation (selling off all assets and paying all debts).
Company Valuations for Investors
Investors from an equity-based crowdfunding platform can determine the value of a recent startup with a slightly different calculation. They can assess the value of the company before it received funding, the value of the company after it received funding, and the multiple of money the company expects to return to investors divided by the amount the investors provided for the lifetime of the company.
Investors can look at how other investors from equity-based crowdfunding sites are treating a new startup to determine whether the startup will succeed. These include whether the company has the following: potential to grow, a functioning product, many competitors, adequate cash to sustain itself and customer validation.
Company Valuations From a Startup’s Perspective
A startup owner is aware that investors see the business as a startup investment — a company in its early stages that may lose money until it solidifies its place in the market. Startup owners are interested in getting a high valuation. They will work to get a higher valuation by identifying ways to beat the competition and show investors that the business plans to grow. A startup owner may use equity-based crowdfunding sites to determine which investors would be good partners for the business.
Investors and startup owners are still developing adequate procedures for company valuation. Parties do not always get it right. Many startups that later burn out make headlines because they were initially overvalued. Investors are starting to be driven to fund more by a company’s plan for those earnings. To judge a startup better, investors and startup owners should review how a company plans to invest its net profit in itself. It helps to determine whether the company’s plan is sustainable, legal, ethical and popular with both customers and the public.
If you’d like to learn more about how startup valuations are calculated, check out this post.