In order to value a company that is an acquisition target, or that can be potentially sold in the near future, we use the market approach, which involves analysing comparable transactions and comparable stock-listed companies. In the case of early-stage startups, this market approach cannot be used as the company is too young to be sold. However, the exit value is fundamental to apply early-stage valuation methods: we need to calculate the future exit value of the company to apply the venture capital or similar methods.
The first step is to analyse comparable transactions or companies. This exercise is different from the standard market approach, as the type of transactions and companies that we take into consideration are very different. I recommend using Crunchbase for the analysis. It is not easy to find valuation figures as these are often private, so in some cases the analysis may have to rely on related but not closely comparable companies. When researching comparables, I recommend prioritising the following:
- Transactions or values not older than 5 years, preferably even as recent as 2-3 years
- Companies in the same sectors with a similar revenue generation model, business model and risk profile, a common target region and without a large debt
- Preferably do not include Unicorns, unless your company follows a similar growth strategy
- Focus on Exit Multiples rather than Early-stage Funding Multiples or Multiples of stock-listed companies
- When sufficient Exit Multiples are not present, it’s also appropriate to use Late Stage Funding multiples or values of Recently Stock-listed Companies
- When there is a choice, deals mostly paid in cash and in full are preferable to deals paid in stock or with an earn-out.
What can aid you in the analysis is also knowing what types of companies would be interested in acquiring the startups and what will be the main acquisition motives.
In startup valuation, the multiples that we calculate also differ, as profit multiples are often not available, or not comparable to our startup.
For startups we prioritise Revenue or User multiples, or alternatively other sector-specific growth measures:
- EV/ Sales outlets
- EV/ Number of products
- EV/ Years of operation
- Other sector-specific figure
The result of the research and analysis would be a table like this template below, illustrating the minimum amount of information to include:
The analysis will provide very valuable information about other companies’ performance, but most importantly, about the typical exit timing for your sector and multiples to use.
When no reasonable exit multiples are found, it is possible to select an EV/Revenue multiple between 2-6x: the more popular the sector, the higher the multiple that you can use within this range. There are cases, especially for new emerging sectors or for non-US transactions, where comparable valuation data is scarce or non-existent. In this case, to demonstrate to investors an active and acquisitive market, you can demonstrate the sector popularity or you can show examples to potential investors (e.g. number of companies recently funded or sold, even if the valuation, revenue or user figures are not available) to prove the validity of your chosen exit multiples, when reliable figures are lacking.
To calculate the startup exit value we usually assume the absence of future net debt, and assume that the Enterprise Value equals the Equity Value.
At this point, you can calculate the exit value based on the startup figures, extracted from the financial plan, in the estimated exit year with the following formula, in this case relative to revenue:
The calculation would lead to a range of values, which you can average or weight according to their reliability if needed.
It would be ideal if values extracted from different multiples come very close, which signifies that companies with similar business models have been used and that the financial plan of the company is proportionate to the market.
The exit value represents the potential future fair market value of the startup: in order to calculate the value of the company today, at time 0, we need to apply valuation methods that involve either discounting this value based on the company’s risk or using a multiplier based on the investor’s return expectations.
A mistake that often takes place is the use of multiples on future plan figures without discounting. This is a practice that leads to overvaluing startups. By using researched multiples based on the financial figures of a company at or before acquisition, these multiples cannot be used on the startup’s next year projected figures, especially when the achievement of these figures is highly uncertain.