Valuing Startup Companies

On February 16, 2013 by Alexander
Startups are strange creatures that defy financial modeling. In practice, valuations are set by negotiation. You make up some stuff that justifies the valuation you want and your potential investor/acquirer makes up some stuff that justifies the valuation they want. Then you sit down and feel each other out until you come to a conclusion.So what should you use to justify your valuation argument?

  • Product usage metrics. There’s no doubt that a company with 120 million users has value. You could, from here talk about the probability of converting those people to paid users, the potential to advertise to them, or compare the number of users you have to the number of users in a comparable company with a known valuation.
  • Demonstrable proprietary advantages. Got patents? Those are worth something. But so are difficult-to-reproduce business processes, user interfaces or customer acquisition plans. Basically you want to show that you’ve got something that would cost a lot of money to reproduce at another company.
  • Comparables. Look, there’s little good data out there on what a startup is worth or why it’s worth that, but your venture capitalist or banker will have some idea of comparables from his or her experience. Ask someone who has seen a lot of startups what they think your company is worth.
  • Market opportunity analysis. Suppose the market for server monitoring technology is $3 billion and you have a technology that could compete against the incumbents and be provided at a lower cost. That may be a more valuable business than a business addressing the market for, say, 8-track audio tapes.
  • Acceleration. People pay for an expectation of continued growth. Pick a metric that looks like it’s starting to hockey stick (asymptotic up and to the right growth) and say that it’s the most important thing, that you’ve unlocked the code to success and that the company should be valued based on that one metric.
  • Really complicated math. Some people are impressed by Monte Carlo scenarios and advanced option pricing analysis. But in Silicon Valley, data doesn’t fly too far. The best analysis comes from comparing to known data on other companies.

But it all really comes down to negotiation. And the value of your startup will be determined by how many potential investors/buyers you can get interested in it and how willing they are to compete against themselves to get a piece of your company’s action.

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