Startup valuation: a simplified guide

Like beauty, value is in the eye of the beholder. Unlike beauty, value is not determined according to personal tastes alone. A startup’s valuation is critically important for both founders and investors as this number determines the amount of equity that needs to be transferred to raise money – and the amount of money that can be raised.

There are a number of factors at play that make startup valuation inherently tricky. You can’t really base calculations on the performance of comparable companies or technologies, like you would for more mature organisations. Available historical data is minimal at best. Multiple funding rounds and fluctuating valuations between them muddy the waters further. All in all, it’s a complex process. But not to worry, we'll walk you through it!

Common valuation methods

Without a crystal ball, how can the future value of a startup be predicted? Let’s have a look at 7 common methods of varying complexity, each with their strengths and weaknesses.

An overview of the methods, their uses and limitations. Image copyright PWC

1. Fixed range

Does what it says on the box: provides a ballpark figure within a fixed range up to 2.5 million EUR. This method is based on a checklist of 5 factors:

• Good idea
• Good team
• Working prototype
• Established strategic relationships
• Initial sales traction in the market

Each of these factors is given a certain score up to 500k EUR.
Pros: very easy
Cons: very generic

2. Cost-to-Duplicate

Literally answers the question "how much would it cost to recreate this company from the ground up?". While this is fairly straightforward for physical companies, it is less so for SaaS or similar businesses with largely intangible assets - although the overall cost of development could be used to represent the cost of the software. Even simpler is to just use the pure accounting value of the equity
Pros: straightforward, supported by facts & figures
Cons: ignores future sales and intangible assets which may hide the real potential

3. Comparable Transactions

Here, we compare the startup with recent transactions in the market. For instance, what does the seed funding round look like, or was a similar company acquired for a certain amount: these provide a benchmark for valuation.
Pros: supported by actions of others in the market
Cons: potentially comparing apples to oranges

4. Scorecard

Building on the comparison method, we use the benchmark set by competitors to compare the specifics of the startup. For example, a stronger management team or tougher competitive environment means adjusting the valuation. The outcome (in this example 1.23) is used as a multiplier to refine a more basic method such as the fixed range approach.

A risk factor summation adjustment (= a list of risks startups have to manage) may also be applied to reflect potential risks more accurately. Each point can have a value attached to it that either adds to or detracts from the basic calculation.

Pros: fully customizable, based on real-world data
Cons: it can be difficult to benchmark all factors correctly, there is risk of double counting

5. Multiples

This method uses financial metrics like EBITDA or revenue and applies a multiple based on industry standards. For example, SaaS companies might be valued at ten times their revenue, depending on growth stages and margins.
Pros: straightforward, widely accepted in negotiations
Cons: this approach is highly dependent on factors such as sector, region, and macro economy

6. VC Method

Developed by Harvard Professor Bill Sahlman, this method estimates post-money valuation by dividing the expected exit value by the anticipated ROI. It’s particularly useful for investments in startups that are ready to scale proven business and where high returns are expected.
Pros: aligns the valuation with the ultimate goal of most early-stage investors: a successful exit
Cons: designed from the VC’s perspective, relies heavily on assumptions of future exit value and RO

7. Discounted Cash Flow (DCF)

This method discounts future cash flows to their present value using a desired rate of return. It is more suitable for established companies with predictable cash flows but may be too complex for early-stage startups with uncertain revenue streams.
Pros: takes a long-term view, incorporates time value of money, focuses on intrinsic value based on actual expected cash flows instead of market comparisons
Cons: highly sensitive to assumptions about future earnings, difficult to apply to early-stage startups with unpredictable cashflow, does not account for market conditions