How to value a startup
Discover the main methods to value startups, the multiples by industry and when valuations are needed. A guide to pre-revenue business valuations.
Establishing what a business is worth is not easy, even for traditional businesses or industries with decades of data. For startups with no historical data or revenue, the challenge is especially hard, which explains why some startups are valued at the price an investor is willing to pay for shares.
Value and price are not the same. It is common for businesses to be acquired for a premium of their valuation, as the acquirer not only values the company as a standalone unit but as the aftermath result of the synergies with the acquirer’s assets, expertise or focus.
On the other hand, some companies are acquired for much less than their value on paper. This can happen when their market position is weakening or the acquirer is only interested in some assets. These differences between value and price are wider for startups.
Reasons to value a startup
Startups are usually valued when additional capital needs to be raised and a company valuation established, but there are many more instances:
- Funding rounds: a business valuation needs to be established when an existing or new investor is willing to buy on primary or secondary. If primary, new shares will be issued and the rest of shareholders will dilute accordingly; if secondary, existing shares will exchange hands.
- M&A: on mergers and acquisitions, the acquirer or the merging companies will always need to be valued, and it will usually be the center of negotiations. If the acquisition is only in cash, the acquirer will not need to be valued, although it is not uncommon to require a founding round to finance the deal.
- Equity plans: it is recommended that companies that have an equity plan in place (especially ESOP or stock options) to update their valuation at least once a year, if none of the other material events have happened. The main reason is that the strike price for which employees and other key collaborators can exercise their stock options, is based on the last company valuation. In fact, it is mandatory for companies headquartered in the US with ESOP to update their valuation at least once a year through 409a, an independent appraisal of the fair market value.
- Strategic planning: it is crucial for scale-ups and big companies to have a team evaluating the performance and future of each business unit or country they operate in. Having independent P&L, cash flow analysis and business unit or subsidiary valuations is key to decide where to invest or focus.
- Inheritances and wills: some shareholders may request to have an updated business valuation to compare the worth of their share with the rest of their assets.
Main valuation methods for startups
The methods used to value a startup tend to change in parallel with the company’s growth: at early stage when there may not even be revenue, the valuation is established with negotiations between the investors and the founding team. Once the company grows and the main metrics are more predictable, other methods can be used.
Traditional companies are often valued at a multiple of their EBITDA (earnings before interest, taxes, depreciation, and amortization), but as most startups have steep losses, their business is valued at a multiple of their revenue. The multiple depends on the industry, business model, growth and other subjective parameters like how experienced the executive team is or how likely it is to get disrupted.
Startup multiples are also impacted by the performance of public companies in the same industry, so if B2B software companies trade at a 20x multiple, private valuations for that segment may also trade at a similar level.
Startup valuation multiples:
- SaaS: usually 10x revenues, but it could be more depending on the growth, stage and gross margin.
- E-commerce: 2-3x revenues or 10-20x EBITDA.
- Marketplaces, hardware or low-margin businesses: 1-2x revenue.
- Travel: 1-2x revenue for low-margin verticals like flights, 6-8x for hotel bookings.
Valuation ranges for pre-seed startups
For pre-revenue companies looking to raise their first round from business angels or pre-seed rounds, the valuation is usually established by the following factors:
- Team: how experienced and complementary the team is.
- Market: the size of the opportunity.
- Approach: what makes the company unique, the product, go-to-market strategy, etc.
Based on those factors, the valuation ranges for pre-seed startups are:
- 1-3 million: average valuation in smaller European markets, Latin America or teams with less experience or targeting smaller markets.
- 3-5 million: average valuation in a tier 1 European market (France, Germany, UK) or with a really good mix of team/market/approach.
- 10-20 million: US startups with support from great venture capital firms or well-known business angels.
Discounted Cash Flow (DCF)
The Discount Cash Flow valuation method takes into account the forecast of future cash flows and returns of investment of the business, calculating the value of the expected cash flow, minus a discount. DCF’s accuracy will not only depend on how precise the forecasts of the company are, but also on how the market conditions and the industry will evolve.
This method is mostly used for big startups or scale-ups, with predictable revenues in established markets, ideally with positive cash flows or EBITDA. We don’t recommend its use for early stage startups due to its inaccuracy..
Startup valuation calculator
There are several online calculators to estimate your company’s valuation, but before starting any of those processes it is important to keep in mind why you need the valuation and whether you need to share it externally with third parties. It will also depend on where your headquarters are:
- Europe: several companies like Equidam or Valorem offer business valuations from 300€, but they will be of little use when fundraising or selling the company, as other factors like negotiating power or how much interest you have from investors will be more relevant.
- United States: We recommend following the 409a standard, which some specialized firms offer for $500, although the pricing depends on the company size.
- Other regions: Equidam and other similar companies offer valuation services online.
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