5 Common Startup Valuation Methods Explained

Figuring out how much your startup is worth is crucial for funding, equity splits, and attracting talent. Here’s a quick guide to five popular valuation methods:

• Discounted Cash Flow (DCF): Calculates your startup’s current value based on future cash flow projections.
• Comparable Company Analysis (CCA): Compares your startup to similar businesses in your industry.
• Venture Capital Method: Works backward from a potential future exit value to determine today’s worth.
• Scorecard Method: Evaluates pre-revenue startups using factors like team quality and market size.
• Berkus Method: Assigns dollar values to early-stage achievements, capping at $2M for pre-revenue companies.

Quick Comparison

Pro tip: Use multiple methods to get a well-rounded valuation. Early-stage startups might rely more on qualitative methods like Scorecard or Berkus, while growth-stage companies can lean on DCF or CCA for more precise numbers.

Related video from YouTube

1. Discounted Cash Flow (DCF) Method

Want to know what your startup is worth today based on its future potential? The DCF method has you covered. It's like a time machine for your money - it takes your expected future earnings and tells you what they're worth right now.

Here's the deal: The riskier your startup, the higher the discount rate you'll use. And a higher discount rate means your future cash is worth less today. Makes sense, right?

How to Put DCF to Work

First, map out your cash flows for the next 3-5 years. Think about everything: how much money you'll make, what you'll spend, and how fast you'll grow.

Next, pick your discount rate. If you're an early-stage startup, you're looking at 30-40% because let's face it - new businesses are risky business.

Then, crunch the numbers using this formula: Present Value = Future Cash Flow / (1 + discount rate)^years

When DCF Makes Sense

DCF works best when you can see the road ahead clearly. It's perfect for startups that:

• Have steady money coming in
• Know their growth path
• Have some financial track record (1-2 years minimum)
• Run on a tested business model

The Tricky Parts

But hold on - DCF isn't all smooth sailing. Here's what you need to watch out for:

While DCF shines for startups with steady cash flow, you might want to look at other methods - like comparing yourself to similar companies - to get the full picture.

2. Comparable Company Analysis (CCA)

Think of CCA like shopping for a house - you check what similar homes in the area sold for. It's the same with startups: you look at similar companies to figure out what yours might be worth.

How to Use Comparable Company Analysis

To value your startup using CCA, first find companies that match your business model and industry. Then look at key numbers like EV/EBITDA (Enterprise Value to Earnings) or EV/Sales ratios.

Here's a real example: Let's say your SaaS startup makes $1M in EBITDA. If similar companies in your market typically sell for 10x EBITDA, you might estimate your company's worth at $10M.

Need data? Tools like Crunchbase and Pitchbook can help you find info about other companies' funding rounds and valuations. The better the match between companies, the more accurate your estimate will be.

Pros and Cons of CCA

Here's what you should know about using CCA:

"Comparable company analysis is a cornerstone of valuation. It's about understanding how the market values similar companies and applying that to your own company." - Marc Goedhart, Senior Partner at Boston Consulting Group

Real-World Example: When Airbnb was getting ready to go public, investors looked at both Expedia and Booking.com to estimate its value. This shows why it's smart to look at multiple companies, not just one.

Keep in mind that you'll need to tweak your numbers based on differences in size, how fast companies are growing, and what's happening in the market. A startup that's growing quickly might be worth more than an older, slower-growing company in the same field.

CCA uses today's market data to find your value. Next up, we'll look at a method that focuses on what your company might be worth when you sell or go public.

3. Venture Capital Method

The Venture Capital Method takes a forward-looking approach to startup valuation, focusing on potential exit values and investor returns rather than current market data. Think of it as working backward from the future to figure out what a startup is worth today.

How the Venture Capital Method Works

Here's the simple truth: this method starts with where you think the company will end up and works backward. Investors typically look for returns of 10x to 30x their investment, depending on the industry and their risk appetite.

Let's break it down with a real example: Imagine you believe a startup will be worth $100M in five years, and you want a 10x return on your money. You'd value the company at $10M today (just divide $100M by 10). If you're putting in $5M, that means the company was worth $5M before your investment.

When to Use the Venture Capital Method

This method shines when you're dealing with startups that don't have much financial history but show promise for big growth. It's perfect for investors who aren't afraid to bet big on potential.

This method works best when:

• You're looking at early funding rounds
• The startup shows signs of explosive growth
• Regular financial metrics just don't tell the whole story

Here's a pro tip: Don't just pull numbers out of thin air. Back up your projections with solid data like industry stats, how fast you're getting customers, and how big your target market really is. Yes, dream big - but keep one foot on the ground.

The Venture Capital Method works great for startups aiming for the stars, but if you need a more structured approach for companies without revenue, check out the Scorecard Method next.

sbb-itb-8981daa

4. Scorecard Method

The Scorecard Method offers a practical way to value pre-revenue startups when traditional methods don't cut it. Unlike the CCA method's focus on financial numbers, this approach looks at key factors like team quality and market size.

Steps in the Scorecard Method

First, you'll need to find the average valuation of similar startups in your market. Then, adjust that number based on how your startup measures up in different areas. Each area gets a specific percentage of the total score, based on what matters most for success.

Here's what matters and how much each factor counts:

Key Factors in the Scorecard Method

Let's break this down with a real example. Bill Payne, who knows a thing or two about angel investing, puts it this way:

"The Scorecard Method allows investors to look beyond financials and assess the true potential of a startup."

Here's how it works: Say other startups like yours are worth about $2 million. Your startup scores 109.5% overall - maybe you've got an amazing team (150%) but need more cash (70%). That makes your startup worth $2.19 million.

What's cool about this method is how it fits different types of businesses. SaaS companies might focus more on tech scores, while biotech firms might care more about clearing regulatory hurdles. If you're selling consumer products, you'll probably want to highlight your distribution game.

Just remember: back up your scores with real proof. Show off your team's past wins or point to solid market research. For early-stage startups, this method works best when you use it along with other ways to figure out what you're worth.

The next section covers the Berkus Method, which takes an even simpler look at startup value by focusing on what you've achieved so far.

5. Berkus Method

The Berkus Method strips startup valuation down to its basics - perfect for early-stage companies that haven't made much money yet.

How the Berkus Method Works

Instead of getting lost in complex spreadsheets, this method looks at what really matters for a startup's success. It puts a dollar value on key elements of your business, with each one worth up to $500,000. For pre-revenue startups, you can hit a maximum valuation of $2 million.

Here's how the numbers break down:

"The Berkus Method is a useful tool for evaluating startups that are too early to have significant revenue", explains Dave Berkus, highlighting why this approach works well for nascent companies.

When to Use the Berkus Method

This method works best if you're running a pre-revenue startup that's aiming to take off in the next 3-5 years. It's especially handy when your company's too young to have the usual financial metrics that investors look for.

Remember the $2 million cap for pre-revenue startups. While the Berkus Method gives you a clear starting point, it's smart to check other valuation methods too - think of it as getting a second opinion.

Comparing the Five Valuation Methods

Let's break down how each valuation method works for different types of startups.

DCF works best for mature startups that can predict their revenue - but it's not great for early-stage companies. Comparable Company Analysis (CCA) helps you set your startup's value by looking at similar companies in your market. For example, if you run a SaaS startup, you can check how much established SaaS companies are worth based on their revenue.

The Venture Capital Method looks ahead to figure out what your company might be worth when investors exit. VCs love this method because it shows them potential returns on their investment. If your startup hasn't made money yet, you'll want to look at Scorecard and Berkus methods - they focus on things like how strong your team is and what your market looks like.

Here's a clear breakdown of each method:

"The DCF method is considered the most accurate for valuing established startups with stable cash flow projections, but it can be less reliable for early-stage startups with uncertain futures", notes industry experts in startup valuation.

Think of these methods as tools in your toolbox - you'll probably need more than one to get the job done right. As your startup grows, you can switch from simpler methods like Berkus to more numbers-heavy approaches like DCF or CCA.

Conclusion: Picking the Right Valuation Method

Figuring out how much your startup is worth isn't a simple task - you'll need to pick methods that match your company's current situation. Pre-revenue startups might do better with simple approaches like the Berkus Method, while companies already making money should look at more detailed methods like DCF.

Here's what works best at different stages:

Mix and match for better results. Using two or more methods gives you a more complete picture and shows investors you've done your homework. Think of it like getting a second opinion - it helps confirm you're on the right track.

Tools to make life easier: You don't have to do all the math by hand. Platforms like Eqvista offer DCF calculators to help with financial projections. Want to know what investors are thinking? VC Investor List can give you insights into what they look for when evaluating companies.

FAQs

What are startup valuation methods?

When figuring out what your startup's worth, you've got five main tools in your toolkit: DCF (Discounted Cash Flow), Comparable Company Analysis, Venture Capital Method, Scorecard Method, and the Berkus Method. Each helps put a number on your company's value at different growth points.

What is comparable startup valuation?

Think of Comparable Company Analysis as finding your startup's "market siblings." You look at other companies that match yours in industry, size, and market position. It's like comparing houses in the same neighborhood - it works best when the companies you're looking at are cut from the same cloth as yours.

What is the best valuation method for a startup?

There's no one-size-fits-all answer - it's all about where your startup stands right now.

If you're pre-revenue, the Berkus Method might be your best bet. It's great at putting numbers on things like your team's potential and your intellectual property.

For startups already making money but still young, the Venture Capital Method shines. It's built to capture those big growth dreams you're chasing.

Got steady cash flow? The DCF Method becomes your friend. It's more math-heavy but gives you solid numbers based on real money coming in.

Pro tip: Don't put all your eggs in one basket. Using a mix of methods often paints a clearer picture of what your startup's really worth. Pick the ones that make sense for your stage and use them together.

Related posts

• How to Create a Pitch Deck That VCs Actually Want to See
• 8 Steps to Prepare for Your First VC Meeting
• Top 15 Questions VCs Ask During Pitch Meetings
• How to Negotiate Better Terms With VC Investors