Value determination is among the most critical steps as part of fund-raising for a startup as it looks to get off the ground. To launch a startup, it must raise funds in a manner suited to accommodate the long-term goals of the business.
Fundraising is not a linear process, and all too often, startups have to go through multiple rounds of funding to meet their goals.
Unlike most established businesses, startups have little to no past transaction history, and hence startup valuation is most often done based on external factors, market conditions, prospects of the business, and founders.
In this article, we will go over the basics of startup valuation to help you get an overview.
What Is Startup Valuation?
Startup valuation is the process of determination of the value of a startup. It takes into account several influencing factors and comparisons with other similar ventures. Valuation for an early-stage venture is typically part of its pre-revenue stage.
The primary differentiating factor from a mature-stage business is the dynamic nature of a startup and the lack of previous business records. Startup valuation includes analyzing the various risk factors, market reception, and considering future growth prospects.
Valuations are subject to change post-launch and can vary depending upon the valuation method opted.
Why Is It Important to Estimate The Value of a Startup?
Startup valuation is perhaps the first step towards financial planning. Before rolling out a business, the owner has several decisions to make. It includes deciding the amount of funding required, the period in which funds will be utilized, and where they will be utilized.
The type of funding to pursue also needs to be decided – equity funding, debt funding, government grants, etc. It would be impossible to determine all this without a proper valuation mechanism. A valuation can also help a business owner determine how much equity to give to investors in return for the funds raised.
Typically, higher valuations would entail lower equity to be provided and vice versa. The valuation of a company is also essential to investors as it helps gauge the return on investment. Proper valuation strategies will paint a clearer financial picture for both business owners and investors, and help ease acquiring funding.
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What Are The Critical Valuation Factors From The Founder’s Point of view?
When it comes to the valuation of a startup, the factors tend to vary from the founder’s and investor’s points of view. For the founder of a startup, the major factors include the following:
Target audience: The founder tends to focus on the target audience, most likely to become potential future customers.
Risk Factors: There are several risks that a business faces and the founder must evaluate all of them carefully. Competition, supply-side crunches, internal issues, etc., are all potential risks. Having a plan of action for these scenarios will help the founder chart a steady course for the future.
Profitability: Depending upon the market and the reception, the founder can determine what the profitability will look like. The ultimate goal of any business is to earn profits, making this one of the most critical factors.
Brand building: An important focus during the initial stages is brand building. The more recognizable and reputable a brand is, the higher its value will be.
What Are The Essential Valuation Factors From An Investor’s Point of View?
Startup valuation factors tend to be slightly different concerning the investor’s point of view. While a founder mostly looks for customer brand creation and reception, an investor tends to be more focused on retrieving investments and making profits within a reasonable time frame. Some of the major factors include:
- Period of investment: Time is almost as precious as money, and hence investors usually tend to opt for those startups that can translate profits soon. The investors who expect a quick turnaround time through an explosion in sales are likely to invest in businesses that depict such trends.
- Return on investment: Investors will only invest provided good prospects for the investment made. Typically, return on investment is the most crucial factor. Businesses that display a good return on investment are more likely to get funded. This is one of the bases on which angel investors make decisions.
- Risk to reward factor: Every startup comes with a risk aspect; however, investors must consider the risk to reward element before investing in a business. If the risk seems proportionate to the reward, investors are more likely to invest.
Startup valuation is a crucial step in the fund-raising process and must be approached with great care. Both founders and investors need to understand that several factors may impact your valuation, and it is not linear.
By carefully understanding the basics of how valuation works, you will be in a better position to gauge the future of a business. This allows both investors and founders to make intelligent decisions with a high chance of success.