Startups Magazine – Valuing an early-stage business

Valuing an early-stage business
2023-06-19Valuing an early-stage business

A well-established business would typically be valued using a discounted cash flow method or a price to earnings method, but as these only really work when there is historic trading and profit data to draw on, they are not well suited to early-stage businesses.

There are many generally recognised ways of valuing a business but eight of these are the Dilutive method, the First Chicago method (DCF triple scenarios), the Venture Capital method, the Scorecard method, the Comparative Market method, the Step-up method, and the Berkus method.  All of these will only ever provide a range of valuations rather than a specific valuation. Where the difficulty really starts is that using any one of these methods will provide a valuation that is different to using any other method. Not only that, but all of them are based to one degree or another on the financial forecasts provided by the founders or directors of the business. As different founders or directors are either more or less optimistic than their peers then this adds further uncertainty.

As such, valuing any business is a very inexact science and when it comes to valuing an early-stage business it is very much more of an art rather than a science. It can be argued that the value of anything is only what someone is prepared to pay for it and that is certainly true when it comes to early-stage business values. In essence, the value is based on ‘hope’ value for what the business might do in the future, rather than what it has done in the past, or even what it is doing now. It is for that very reason that investors pay such close attention to the experience of the founder and the senior management team and close advisors.

Businesses that are predicted to scale quickly will always have a higher valuation than those businesses with slower growth expectations. Fast growth business would normally include those in sectors such as tech, fintech, life sciences, and the like, or businesses using a SaaS model that can quickly build monthly recuring revenue. It is no coincidence that it is those businesses that VCs also favour.

However, as the economic climate has become ever more challenging, and businesses have struggled to hit projections and meet targets, it has become apparent that many valuations were rather optimistic – especially in the tech and other similar sectors. 2023 has seen a reappraisal of business valuations across the board, but especially in those sectors that have historically attracted the highest multiples. Raising finance in 2023 is not only more difficult, but investors are much less willing to accept higher valuations.

When raising finance, getting the valuation wrong does of course have important ramifications.  If your business is undervalued, you are giving away more of your business than is necessary in order the raise the funds required. But if it is overvalued, not only will it be much more difficult, or even impossible, to raise the investment required, but it will also make it more difficult to demonstrate good capital growth in the future and that may impact on subsequent rounds.

At BOOM & Partners we would always advocate that it is best to value your business using a number of different methods and then also consider how much investment is being sought and where you are trying to raise it. For an early-stage business, a combination of a detailed scorecard method and a comparison method would normally produce the most reliable valuation, but any valuation will only ever be a range and then logic and ‘gut feel’ also needs to be applied. Just remember that this is one of those situations where it can often be a case of ‘less is more’ over the long term.

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