HOW TO VALUE A STARTUP WITHOUT A FINANCIAL PLAN

 

It is possible to value an early-stage company. In fact, most seed stage startups are valued this way, without carrying out complex valuations or projections. However, this makes the valuation highly uncertain, since the financial projections are also part of a company’s business model validation. Another important weakness is that without a financial plan, the amount if investment sought cannot be estimated correctly, and that founders’ expectations regarding the funds to raise is usually wrong, sometimes setting the bar too low (not taking into account cash flow risks) or too high (not having a realistic view of how much can be raised on the market at a certain stage), which results in unbalanced valuations.

There are two pieces of information, that despite the lack of a financial plan, are extremely useful: revenue and the number of users/customers at the time of exit. Without these, the most used methods cannot be applied, such as the venture capital method, or any method involving the calculation of an exit value. However, it may be possible to estimate an exit value and time to exit based on the sector average, by analysing comparable exits, especially when the sector has stable trends; less so when exits do not appear to follow a specific trend or when data is scarce. Of course, projecting the number of users and revenue in a simplified manner, without using a market top-down approach, would not provide us with very reliable figures, so it is recommended to use the lower multiples within the range researched.

The methods that can be used without any problem in the absence of financial projections are rule of thumb methods, which, however, are only suitable for early-stage startups. When done correctly, these may even be more reliable than exit-based method, as they take into consideration the current funding market trends.

Another method that can be used, only in circumstances when the company has had a recent round of funding, is the Price of Recent Investment Method. Even when no proper valuation had taken place at the time, a recent valuation would indicate how the company is valued in the market, provided that the investors are not friends & family or have other non-financial interests in the company.

Additionally, the Valithea Method ™ is another rule of thumb method that estimates the value of a company by using a mix of the above methods through a multiple choice questionnaire and approximation of market trends for different types of companies.

Since none of the methods used for startups can be totally reliable due to the high uncertainty of early-stage investments, we should calculate an average of two/three methods to arrive at a valuation.

To summarise, we can use any of the following methods to calculate the value of a startup, in the absence of a financial plan:

  • Exit-based methods by using an approximation of the exit value – VC Method, Hybrid Income/Market Method
  • Rule of thumb methods – Risk Factor Summation Method, Scorecard Valuation Method
  • Price of Recent Investment Method
  • Valithea Method ™

Without a financial plan, we should not consider any valuation exercise to be foolproof and the result should be a Value Estimate rather than a Calculated Value, to be used for low-risk transactions or last-minute negotiations. A Calculation Engagement Report or a Valuation Engagement Report should not be prepared in these circumstances.

To understand how these methods work in practice and how to apply them correctly, please refer to the e-Book on Startup Valuation or access our growing library of Calculators.