The 10 Characteristics Of Startup Valuation

Startups are innovative, fast-paced, and highly dynamic entities that play a crucial role in shaping our modern economy. But behind every successful startup is a careful and strategic allocation of capital that allows the company to grow and flourish. One of the most critical components of this process is startup valuation, which refers to the process of assessing the worth of a startup company.

But how can we all agree on an appropriate way to approach early stage valuation? At this stage the process really only produces an opinion on worth, and the validity of that opinion – the test it must pass – ultimately comes down to what the market is willing to pay.

As a founder, you can’t control external influences like general supply and demand for startup equity or the number of competing deals, but you can do your best to make sure that opinion on your value is based as firmly in reality as possible. Be honest and objective about your businesses strengths and weaknesses, as well as your ambitions as a founder.

Check your valuation process and outcome against these 10 points and make sure you are ready for investment talks and negotiations.

Checklist for your startup valuation:

1| Produce ambitious but realistic projections

Valuation is commonly based on financial projections and growth, and even for startups these forward-looking calculations can play an important role in valuation. To make sure you’re not significantly overshooting, your projected growth should not exceed a reasonable market size estimate, and where possible you should benchmark those projections against publicly available data of similar companies.

2| Understand current market conditions

Always keep a close eye on the economic conditions. As mentioned above, startup valuations got a little bit out of hand in 2021/22, so you should avoid using comparable data in your valuation from other startups in that period. Instead, you might want to look at a period when the market was similar – which we’d suggest was perhaps 2019.

In the same way, make sure you use the financial information that comparables (similar companies) disclosed in the appropriate funding rounds. Similar companies should be identified by stage of development, geography and business model.

Good sources to start your market research are Angel list and Crunchbase.

3| Spotlight your intangible assets

Investors commonly value startups based on the strength of their entrepreneurial team, the product, and the market using qualitative frameworks like the Scorecard or Checklist methods.  If your company is pre-revenue, then emphasize the product or the market potential, play on your strengths and acknowledge your weaknesses.

Investors tend to highly value previous entrepreneurial experience. If you have been a founder before or you have strong expertise in your field, make sure to capture it in your valuation. And while it’s important to clarify the strength of your team and the size of the opportunity you are attacking, you should also focus on why your team is the right fit for that opportunity.

4| Tell a cohesive story with numbers and narrative

Valuation is just your opinion of what your business is worth today. The financials projections and the market research for comparables are your argumentation. But they don’t stand on their own. The background, the context behind these numbers is pivotal. A good story is the basis for a good valuation, and it must be possible, plausible and probable.

5| Have a clear vision, be flexible on the details

Present your valuation clearly. Display and underline the value drivers and your assumptions. A good valuation is not the one that calculates the perfect number, is the one that shapes the discussion in an open and constructive way, and that allows the two sides to arrive at a deal which works for everyone. It is a high-resolution picture of how you see the future potential of the business, and while an investor may disagree with that vision, it should just be a matter of calibration to arrive at something reasonable and agreeable.

6| Use valuation as a measure of progress and potential

Startup valuation is not only useful when it comes to fundraising. If calculated in a reliable way, your valuation can turn into a metric to use when tracking your progress and growth.

Your valuation calculation should be repeatable. Try to always use the same methodologies even if the assumptions behind your financials or your strategy are changing as this will create a useful historic benchmark. Understand how decisions you’ve made have influenced the value of your business, and even model other scenarios to get a perspective on future possibilities.

7| Calculate your capital requirement 

In your valuation, take into account the amount of capital that you need to achieve enough milestones that you can consider raising the next round. Generally, you should account for at least 18 months of operations until you need to raise more, though in difficult fundraising environments now you might consider raising 24 months or more. To estimate the amount you need, take into account any planned product releases or hires. Also consider the current burn rate of the company, and the time it will take to achieve revenues.

In understanding your capital requirement, you can look at a presumed valuation and understand just how much equity you would have to give away in exchange. It might be that you find yourself having to give away far too much equity to make the deal viable, in which case you might have to fundamentality rethink your strategy. It’s also possible that you’ll find you’re not really giving up enough equity to be interesting to most investors. Consider the usual amount of equity offered at each stage.

8| Consider subsequent rounds and founder dilution

The valuations of future funding rounds determine how much equity founders early investors retain when an exit comes.  It is useful to reverse the process and start from the amount of shares the founding team would like to keep and then calculate the current valuation as well as project the numbers for future rounds.

This means you will consider and model your dilution in future funding rounds. In this article we explore the fundamentals of dilution and offer a few example calculations.

9| Offer a range, but consider what the low end entails

Valuation often is the deal breaker of investor negotiations, so it is important to demonstrate that you are flexible and open to discussing different perspectives on the drivers of your valuation and how that may influence the outcome. Start by laying out a range rather than a specific number, though be clear about the kind of support you expect from your investors if they gravitate towards the bottom of that range. It might be that you can compromise on that in exchange for access to their network or ongoing mentorship.

10| Understand clauses and how they affect your valuation

Consider the terms and clauses of the deal for your funding round as they could affect the valuation. For instance, venture capital funds often include liquidation preferences in their investment contracts. Liquidation preferences give investors the right to be paid ahead of other parties. This lowers the risk for investors potentially allowing you to negotiate a higher valuation. In the end, valuation is only a part of an investment deal, and should be considered and negotiated together with all other clauses.

Calculating the fair value of a business is tricky and always involves research and, later on, negotiation.

Always keep in mind that every funding round is in the end a partnership with people that are going to stick with the company for many years. Startup valuation and more in general the investment process are finalized to a deal. The deal should be fair and a win-win to both parties. The outcome you are looking forward is always the excitement of forming a partnership that is going to change the world.

Make sure valuation isn’t a deal breaker for your startup. Get started with Equidam!