Part 13: How to value your start-up
Valuing a start-up can be a tricky, especially if your business doesn't have reliable free cash flows yet. This is a question we often get asked by start-up founders, and we understand the importance of getting it right.
Firstly, it's important to understand that it's relatively "easy" to value companies with free cash flows. Scratch that, we shouldn’t say easy. It can be hard, too. But there are established ways of valuing mature businesses. You would typically use a discounted cash flow (DCF) analysis or multiples on your EBITDA.
However, for start-ups without reliable free cash flows, or no cash flows at all, DCFs are not relevant. Here are a few approaches you can use to value your business:
Based on your funding ask. You will typically sell between 15-25% of your company. So if you are raising a $1M (because that’s what you need according to your OPEX and CAPEX plan), that gives you a clear range about what the valuation of your business is ($4-6.6M).
Based on your revenue. Revenue multiples have varied in recent years, but right now, they seem to be closer to 5-25x. So if you're making $250K in annual revenue, your business would be valued anywhere between $1.25M and 6.25M. Since there’s no formal data on revenue multiples, you can try to look at P/E ratios of publicly listed companies in your space as a benchmark.
Based on the value of peers. This means that you look at a set of close peers that are roughly at your stage and value your business according to what they were valued at. This approach can be limited by publicly available data. PitchBook can help but will be too expensive for most start-ups.
Based on emotions. If you have a lot of FOMO going for you, you can potentially significantly increase your suggested valuation. However, you need to be able to grow into your valuation, or you're facing a down round next time around, so be careful about how high you set your valuation.
Based on the cost to duplicate. This is particularly relevant when you talk to strategic investors, which are typically making a buy vs. build evaluation.
Finally, early-stage start-ups always have the option to avoid valuation discussions by opting for a SAFE round. If you’re raising via a SAFE note, you don’t need to establish a valuation just now. Instead, you’ll set a valuation cap and or a discount and defer the valuation negotiation to your next funding event. This can significantly shorten the negotiation process and thus get you to close your round faster. By the time your next funding round comes around, you may have revenue to inform your valuation.
Talk soon,
Rafael
PS: How do we help you? My team and I build pitch decks, review existing decks, and offer pitch simulations. Get in touch if you or someone you know may be interested.
PPS: This mini course is based on our popular “Fundraising & Pitch Deck” newsletter.