The excel valuation here illustrates the basic steps to the calculation of value for a small early-stage growing business, including:
– the calculation of the discount rate (in this case an alternative approach to CSRP calculation is used)
– the Discounted Cash Flows (in this case the Net Equity Method is used instead of the WACC, which in the absence of debt results in the same value)
– the Market Approach, which in this case includes mostly exits
– The Valuation Summary
Depending on the circumstances and characteristics of the company and transaction, the Cost method can also be used, and different versions of the Income and Market Approach can apply.
Additionally some transaction-specific features, such as the calculation of synergies, sometimes are added. Additionally, the Valuation Engagement would include more advanced methods to calculate the discount rate and the terminal value, among other features.
Prevalent valuation methods can be applied to startups as well, but with a variety of adjustments that are necessary to illustrate the different features.
For startups, the calculation of a discount rate is rather different, as it is stage-specific and it reflects more the expected return on investment of early-stage funds and high failure rate of startups than other observable market risks and returns. The higher discount rate of startups is also a sign of inflated financial projections as startups strive to sell themselves as potential unicorns. The discount rate in this case is only applied to the exit value, or used as an adjusted multiplier.
While a cash flow statement is very useful for startups, discounting cash flows is less useful, particularly at very early-stages. Investors only earn from a liquidity event such as an exit and IPO, and therefore discounting cash flows would be less suitable. Also, the focus for startups is on growth rather than profits, with likely multiple rounds of funds and any excess cash flows reinvested into the business, rather than paid out as dividends, and any spare capacity will be used to further scale the company and maximise the exit. However, a DCF can also take place for a startup if a number of adjustments are applied (which we will review in a later post).
The market approach takes place in a similar fashion for startups. However, the type of transactions considered should be more similar to the startup in question (at exit time). This means that both startup acquisitions, late stage funding and startup IPOs can be considered. Data here is more scarce, and business model comparability is more important. A variety of sector-specific multiples can also replace the lack of other financials for startups.
For early-stage startups, the market approach is applied to calculate the future exit rather than the current market value. To substitute this, other seed stage methods can be applied, and rounds of funding at the same stage of comparable companies can be researched to calculate the current market value (after adjusting for differences in comparability).
For startups, we are likely to compare or average different methods used, and then adjust for potential dilution and other factors. The stake of the funds to raise is calculated based on this. The ROI and Cap table are also displayed in out startup valuations.