Written by Michelle Tarunadjaja
One of the first things you learn as an analyst at a venture fund is the approach to valuing early-stage startups.
Unlike financial analysts that have access to abundant historical data that allows them to do a bottom-up DCF analysis, any data that is available from early-stage startups will be difficult to use to accurately project future value. So, the approach is simplified for VCs and startups.
The good news here is that any founder can perform these calculations with some straightforward research and present a solid rationale for the valuation they’re presenting.
To clarify, this is not the only valuation method that exists; a wide variety of approaches have been used to evaluate young companies such as theas well as the . By and large however, the most commonly used method for VC firms is some form of the Comparable Method. As such, it is never a bad idea to calculate this for yourself to get a sense of where a VC would place your company’s value.
Here are three straightforward steps to perform a startup valuation using the Comparable Method.
For this example, we will use an ecommerce startup. A commonly used north star metric for a startup in this category is gross merchandise value (GMV), which is simply the sum total sales value of merchandise sold on an online retail site over a period of time. This will be the baseline metric we will use to evaluate the startup.
Step 1: Find proxy companies and research their traction
Let’s assume that your startup is an ecommerce marketplace specializing in electronics across Southeast Asia. The first step involves identifying companies that have similar business models (in this case, an ecommerce marketplace) operating in a variety of markets.
(Note that it is preferred but not essential to do your comparisons with companies in similar funding stages.)
In many cases, both GMV and valuation figures can be extrapolated from publicly disclosed fundraising announcements. We can assume that the amount represents 20 to 30 percent of equity at that point in time. So in the case of our research below, valuation equals the fundraised amount divided by 0.2.
Step 2: Calculate the average valuation multiple of your industry
In order to check how much our ecommerce startup is valued, we are essentially checking how much the other companies would have been valued if they had similar traction to it.
To do this, we need to have a valuation multiple to scale it up or down. A valuation multiple is a ratio that is calculated by dividing the value of a company by a key indicator of the business. The key is to find the primary indicator and the driver of value for the company. In this case, we are using GMV.
Some other commonly used indicators are annualized revenue, annualized loan disbursed, and monthly active users.
Based on the research above, we can calculate the respective valuation multiples on the five businesses we are comparing against and find that they range from 1.2x to 3.3x. As there doesn’t seem to be any outliers, we can average out all of the comparable companies and come out to a 2.1x valuation multiple on GMV.
What this shows is that based on these companies, for every US$1 in annual transactions, their enterprise value or valuation is US$2.1.
Step 3: Derive your startup’s valuation
Once you have your valuation multiple, the last step is to simply apply the multiple to your company’s current GMV metric.
If, for example, this ecommerce startup is generating US$20 million in annualized GMV, based on this valuation exercise you could make a case that it should be valued at US$42 million (2.1x) or somewhere in the range of US$24 million (1.2x) to US$69 million (3.3x).
As mentioned before, valuing startups is not an exact science; this number should only be a benchmark for your discussion with the VC, and you should be open to discussing why this number may or may not make sense.
An important consideration at this stage would be the various ways your company differs from these comparables. If, for example, your company has much weaker unit economics, the investor may argue that your valuation multiple should be on the lower range.
Similarly, if you have a competitive advantage, you can argue that the valuation should be higher than the industry average.
Although you would probably present your valuation based on the average multiple, you should also be aware of the various arguments against it.
Ultimately, every fundraise will involve negotiations regarding valuation. Despite how intense negotiations get, it’s important to keep in mind that good VCs will not try to undervalue your startup.
Investors will try to evaluate as fairly as possible. It will keep the founders incentivized throughout the journey and give them the best chance at raising enough capital to sustain the business until they can exit.