Valuation is subjective and depends quite a lot on the perception of the valuer. For the investors, one of the most difficult tasks is to determine the price of the investment. In other words, the investors need to decide on the amount of equity or ownership interest they should gain in exchange for the invested capital. On the other hand, the entrepreneurs are concerned about the amount of equity they will need to issue.

By virtue of its nature itself, valuation is not an exact science and this becomes even more challenging for startups. Startups would usually have negative but growing cash flows, limited or no historical financial data, and a developing market or product market fit still being determined. Due to these factors, traditional approaches such as PE multiples, EBITDA multiples, net assets approach, etc. will not work as startups generally do not have the financial performance indicators to capture these approaches effectively. Startups often don’t have enough concrete data at the early stage and, moreover, they face a range of risk factors that could change the course of the business.

Valuation of a startup brings various challenges, which require it to approach the process differently. As historical information is unavailable/ limited and forecasts are uncertain, qualitative elements play a significant role. Accordingly, indicators such as management experience, current customers and revenue, defined target group or a Minimum Viable Product (MVP) should be taken into account in the valuation process. Factors that make up the valuation include the development stage of the product or service, proof-of-concept in its market, the founders and their team, valuations of peers or similar startups, existing strategic relationships and customers and sales. Many traditional valuation methods, such as discounted cash flow, aren’t as useful for valuing early-stage startups. This means investors have to gauge other factors that aren’t so easily measured.

The valuation process includes researching similar companies and often uses a simple framework for decision-making. Thus, it is very important that a valuer should consider other qualitative parameters which need to be decided depending on various factors and may be different for different startups. Further, there may not be a single valuation method which works for valuing a startup, or there can be various methods that may be used for valuing the same startup. The eventual choice of the method to be used should be made after considering the characteristics of the company and the industry.

There isn’t a straightforward formula to follow when valuing a startup. Since most startups can’t really prove their commercial success at a large scale, valuations rather take into account the nature of the product or service, projections for the business and the market size and opportunity.

Truly, valuation is more of an art than a science.

Redbrick Capital Advisors is India’s leading investment bank with expertise in private equity, mergers and acquisitions, and debt syndication, with an exclusive focus on startups and SMEs, across all sectors and industries. Our experience, expertise and domain knowledge across sectors and categories have helped us build credibility in the market and execute the transactions successfully. If you need help to steer your business through the complex financial world and get it on a path of smooth growth, write to us at: mailus@redbrickcap.com