Early stage valuation is considered an art by many. However, as all arts, methods and best practices apply and bring the art forward over time. For early stage business valuation, different best practices have been developed recently to account for the modernization of investing.

Different stage, different approach

Public company valuation has best practices that have been applied to startups or early stage companies for a while. However, in the past years, more analytical and professional business angels developed different ways to value small companies starting from the assumption that methods for big corporates could not be applied to these risky, unpredictable ventures.

These valuation methods incorporate the fact that business plan, strategy and outcomes change on a daily basis. Projections are based on so many assumptions that they have very low value and often only respect the dreams of the entrepreneurs. As Brad Feld in his book “Venture Deals” would state, “the only sure thing about projections is that they are wrong”.

From these assumptions, business angels like Dave Berkus and associations as the Kauffman Foundation developed business valuation methods that value companies based on the factors that contribute to business success. We already summarized these factors a couple of weeks ago, now we are going to go more in detail in regard of how these factors are actually computed to get to a final valuation estimate and the intuition behind.

1. An evolution of the accounting “value of assets” method

Accountants, among other methods, consider the book value to calculate how much a company is worth. The book value is in essence the sum of the value of the assets of the company. It does include tangible and intangible assets but often, especially for just born companies, it does not include goodwill. Goodwill accounts for all the intangibles that are not considered in other categories, and it is generally determined only if the company has been acquired. For this reason, usually the book value is lower than the acquisition value, which is what the investor is interested in.

To compute goodwill and thus full startup valuation, these methods take into consideration the sum of the assets of the company in their broadest sense. For example, team knowledge and experience are indeed two of the main assets, even though they would not appear on the balance sheet.

Furthermore, synergies are not computed. If, for example, a company acquired two patents, the balance sheet will show you the acquisition costs. The business angel will value them in combination with looking at the vision of the company and at the reason to buy them. If the vision is strong and these patents are pivotal, it is very likely that their combined working value is much higher than the acquisition cost.

2. Comparability

The second type of method used by business angel starts from another intuition of the stock market: comparability. On average, company prices should be correct if properly scaled by certain key attributes. For the same principle, on average, startup prices should be correct once scaled by different key attributes. In other words, if the average value of a startup that has a prototype is 1mln, your startup should be worth around 1mln, more if your other attributes are better than the average, less if they are worse.

As a company grows, its risk lowers and the assumptions that make financial projections reliable are less uncertain. For this reason, as the company grows, financial methods and projections become more important and the qualitative attributes of the startup- less. However there is still space for projections in early stage companies, if not for other reasons, just to show investors your ambitions and that you know how to work with numbers. We have recently released a financial projections template for FREE that simplifies your calculations!

Do you know the value for your company? Get started with Equidam and find out!