23/08/2022
How is Startup Valuation determined by Registered Valuers?
Startup companies receive different kinds of funding for supporting the business to grow and build up. There are various options for fundraising for startups in India such as angel investors, venture capitalists, crowdfunding etc. At Ozg Finance, we offer you all services at single window in association with numerous players across the country.
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The registered valuers for valuation in India i.e., Insolvency and Bankruptcy Board of India (IBBI) consider a set of positive and negative factors. The positive factors include a reputation or brand value, customer traction, a prototype of the business, revenue generated till the time, supply and demand including distribution channels, and market value. The negative factors for valuating a startup include low margins in price determination, poor industrial value, market competition, product offerings, and management of the business. Right from your first inquiry, our 24/7 support desk and Ozgian(s) help you to work up on it.
METHODS OF STARTUP VALUATION:
There are different methods to calculate the valuation for new business. Some of them are simple, while most of them are based on several qualitative variables and statistical analysis.
📌 1. Venture Capital Method (VC Method):
The venture capital method allows a startup to evaluate the forecasted terminal value by establishing the return to be paid to an investor. It is well-suited for the pre-revenue startups involving pre-money valuation. The pre-money valuation is calculated by subtracting invested capital from post-money valuation, in which the post-money valuation is obtained by dividing terminal value with an expected return. It is the simplest method to calculate startup value. This method is suggested by most reputed fundraising for startups in India.
📌 2. Cost to Duplicate Method:
This approach is very realistic as it calculator the net worth of all the hard assets of a startup and determines the cost to replace it and re-establishing it somewhere else. The investor will fund the amount that is needed to duplicate that particular business. However, it is done for the time being and does not include the future asset valuation anyway.
📌 3. Berkus Method:
Berkus method evaluates a startup based on the business idea, the prototype of products or services offered, quality of the management team, strategic relationships or alliances, and sales forecasting. Each of these criteria is associated with a certain amount of money.
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📌 4. Discounted Cash Flow (DCF) Method:
This type of valuation method for a startup is used for estimating the overall value of the investment on the basis of the future cash flows.
DCF analysis is known to analyse the respective attempts towards getting an idea of some current investment –depending on the projections of how much money it is going to generate in the future.
Preparing the Valuation under Discounted Cash Flow Method -
Step I: Assess the firm’s Current Standing:
What are the firms current year revenue; What is the cash Burn rate of the company; Industry projection.
Step II: Estimate Revenue Growth:
This can be identified in the following ways -
🖍️ Past growth rate in revenues at the firm itself.
🖍️ Growth rate in the overall market that the firm serves.
🖍️ Barriers to Entry and Competitive Advantages possessed by the firm.
Step III: Estimate a Sustainable Operating Margin in Stable Growth:
This can be identified in the following ways -
🖍️ Looking at the underlying business that this firm is in, consider its true competitors.
🖍️ Deconstruct the firm’s current income statement to get a true measure of its operating margin.
Step IV: Estimate Reinvestment To Generate Growth.
To grow, firms have to reinvest, and this principle cannot be set aside when you are looking a young firm
Expected growth = Reinvestment rate *(multiplied) Return on capital.
Step V: Estimating Risk Parameters and Discount Rates:
Risk, in traditional terms, is viewed as a ‘negative’. But it has two facets one is “Danger” and the other is “Opportunity”. Risks are termed as BETA.
📌 5. Scorecard Valuation Method:
It utilizes the comparison of the pre-money valuation of the startup by incorporating a scorecard. The average pre-money valuation of the startups in a region is calculated giving importance to certain criteria such as the size of the business, the strength of the central team, the technology used, competition, marketing channels, and investment options. The scorecard is made by assigning factors to each element and comparing it with a standard.
This the most the used method in valuation , the components being the Weighted Average Cost of Capital, Beta being the risk factor, Cost of Equity and other factors that are used to determine the present value of future cash flows.
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📌 6. Risk Factor Summation Method:
There are 12 factors that are considered for the evaluation of the worth of new business. These factors are - business stage, management team, political risks, manufacturing risks, sales and marketing, capital funding, competition, technology, litigation risks, reputation related risks, and potential lucrative risks. Every factor is analyzed as positive, negative, and neutral to determine the valuation. The registered valuers for valuation in India combine this method with other valuation processes for business valuation.
📌 7. Business Stage Valuation:
A quick range of validation needed by angel investors and venture capital firms in order to fund a startup. The business stage valuation method evaluates various stages of funding with respect to the risks of investing in a startup. It is based on the estimated company value, stage of development, business idea, management team, product prototype, and strategic alliance or partners in the business venture.
📌 8. Probability Methods:
There are some other probability methods such as the comparables method, the first Chicago method, and the book value method. They are all based on assumptions and future probability, without any mathematical or data analysis. The startup valuation is done based on best-case, worst-case, and normal case scenarios.
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📌 9. Startup valuation revenue multiple:
In startup valuation revenue multiple method , registered valuers generally use, the two most reliable values -
a) Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA).
b) Seller Discretionary Earnings (SDE).
EBITDA is used almost exclusively for companies larger than $5M in value and is calculated by adding interest, taxes, depreciation and amortization back to your net income. For businesses under $5M in value, Seller Discretionary Earnings (SDE) is typically used. SDE is the profit left to the business owner once all costs of goods sold and critical (i.e. non-discretionary) operating expenses have been deducted from gross income. Crucially, any owner salary can be added back to the profit number to reflect the true earnings power of the business. Essentially, SDE can be expressed with the following simple formula:
SDE = Revenue – Cost of Goods Sold – Operating Expenses + Owners (Founders) Compensation ( i.e. Directors Salary or any other compensation provided).
This is the figure that we recommend you apply the multiple to when calculating your company’s value.
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