I’m currently working with several of our startups that are preparing for their next funding rounds. During our discussions, a common question our entrepreneurs ask is how their startup should be valued.
We then go through the different ways in which most startup investors think about valuations. We look for benchmark revenue, gross profit, EBITDA, or other multiples which we then adjust for differences in the target market size or growth rates of our company and the benchmark company. We also start off from the size of the market our startup is attacking and apply successive shares for the percentage of the market that will be online and the company’s eventual market share in the online part of the industry, before then discounting the result by the investor’s return expectation to arrive at a valuation. There are other creative approaches.
Depending on the approach and the assumptions we use, we reach a pretty wide range of potential valuations. This is why valuing companies, and especially startups, is an art, not a science.
However, I always conclude our discussion by stating what I believe is the most scientific part of the valuation process. For most startups, it’s also the single most important factor for the company’s valuation. It’s the number of bidders you have at the table.
The more investors you can convince to believe in your startup and offer to invest, the greater your negotiating power. Investors also talk with each other so they’re likely to know when there’s competition for a deal. And you can always tell them that you have competing offers. Just be sure to be truthful (again, investors talk with each other so if you’re not truthful they’re likely to find out) and try to respect each investor’s privacy by not sharing their identity with other investors.
And the greater your negotiating power, the better terms, including valuation, you will be able to secure for your startup. In the art of the startup valuation process, the law of supply and demand is perhaps the only science.