Valuing tech startup company
Valuing your tech startup company is crucial when you are planning to sell your company, but also when seeking investment. However, the question is how do you value a tech startup company? The answer to this question is rather the art than a science. There is no right answer, the company valuation depends on the investor’s decision and how much they are willing to pay.
To determine the value of your business, financial experts and investors will mostly use the following methods.
Multiple of Earnings
This refers to the average monthly or annual profits adjusted to not include one-off factors such as exceptional costs or one-off purchases. This will give you a good idea of immediate future profits. To get the valuation, multiply this number between three and five, but don’t be too optimistic if you’re only a small company.
Moreover, this is a very good tactic for companies with a solid track record of successful and profitable margin.
A look at Apple’s P/E ratio over the years reveals that the company’s price/earnings ratio has a positive correlation with its price. In other words, the P/E multiple is one of the signals that traders use to determine opportunities whether to buy or sell.
For more detailed valuation methods, take a read at startups company valuation guide.
For start-up companies with promising ideas but no actual businesses, the sensitivities can be a lot higher. For example, a start-up company that needs to invest $50.0 million to build a business that could be worth $1.2 billion with a probability of 5% and completely worthless otherwise. Its estimated value today would be $10.0 million. But if the probability of success were to fall by just half a percentage, its value would decline by more than half.
It is no surprise that the share prices of start-up and high-growth companies are typically far more volatile. When compared with companies with mature businesses, a tech startup company can be unpredictable.
To calculate your asset valuation, take the value of your assets and subtract your liabilities. This method of valuation usually produces the lowest valuation. Have in mind that this method does not take into account the potential for future earnings.
That said, there is no single point valuation for a tech startup company. However, the already mentioned methods could help with the overall strategic company valuation.
Discounted cash flow
Discounted-cash-flow valuation, although it is a well-known method in finance, works where other methods fail. The core principles of economics and finance apply even in uncharted territories, such as startups.
A discounted cash flow model takes into account all the factors that could affect a company’s current and future performance. There are also factors that impact the DCF model such as external and internal. For the internal factor consists of most of the data that a financial analyst has to consider. However, the external method will include the impact of competitors and market growth.
Moreover, McKinseys recently argued, in their article (Valuing high tech companies) that it might feel positively retro to apply DCF valuation to hot start-up technology companies, but it is the most reliable method.
As an example, take valuing tech startup, the cost-to-duplicate a software business might be high. Let’s see it as the total cost of programming time that is gone into designing the software. For a tech startup, there could also be the cost of research and development, patent protection and prototype development. The cost-to-duplicate approach is often seen as a starting point for valuing startups.
After all, it is based on verifiable, historic expense records. However, the problem a lot of tech founders will see here, is that it doesn’t reflect the company’s future potential. Moreover, the cost-to-duplicate method does not include intangible assets such as brand value.
So, physical infrastructure and equipment may not be the only thing that matters, in fact, the actual net worth lays in intellectual capital and relationship.
Technology businesses are quite often valued based on the number of customers/subscribers, the stickiness or customer retention and the uniqueness of the IP, patents or technology platform that has been built.
When valuing a tech startup, oftentimes, the potential synergies that they provide to a buyer and the current market sentiment are factors that come to play the same as the revenue the startups have.
Remember that valuation is a starting point for indicating the value of your business. For more read on how to value a startup, check out the Early-stage company valuation guide.