How much is your startup worth?💰
The million (or billion) question dollar question that every founder wants to know: How much is my startup worth? The cold and not sexy answer is that… it depends.
I’ll dedicate this post to defining a few metrics for the valuation of startups - specifically in the context of acquisitions.
Ultimately, the final price for a business is determined by the negotiation between two parties: the seller and the buyer. This means that a lot of factors affect the value: how unique is the business being acquired, what are the potential synergies with the combined businesses (in case of an acquisition), and how much capital available the acquiring party has… which means that sometimes is as much about them (the buyer) than about you (the target). To simplify the equation, I’ll keep our discussion focused only on traditional finance valuation. I’ll also assume that we are talking about a startup that already has a few (2-3) years of operations, with revenues and is self-funded (for pre-revenue startups this article is more comprehensive and has a few options in case you’re interested to learn more).
In traditional finance, there are two main methods to calculate the value of a business: comparable transactions and discounted cash flow.
Comparable Multiples:
Most popular method used for startup valuations. You basically gather a group of transactions in similar space as your business, and take the implied multiple of revenue, EBITDA, users, etc. of the total value of the acquired or funded company. For example: a business acquired for $100 million with $10 million in annual revenue would have an implied multiple Valuation/Revenue of 10x. Investors and buyers also use public listed companies in the industry and check at which multiple they are trading (eg. freelancing platform Upwork has annual revenue of $560m and trades at a market cap of $1.6bn, which means that the implied revenue multiple is 2.68x)
There are also some sector-specific multiples, such as the SaaS multiple calculated by debt provider SaaS Capital, that combines the Annual Recurring Revenue (ARR) growth rate, and Net Revenue Retention Rate to calculate the multiple that the SaaS startup should be worth. Since these are standard metrics in the industry, it’s a quite well adopted metric in the tech and venture capital industry. More details here.
The “comparable multiples” method is the main reason why when there is an economic downturn there’s a snowball effect to private markets transactions - as investors use either transactions or public listed companies multiples to calculate the benchmark for valuations of startups, when these stocks are trading at lower multiples, there is the same impact in the value perceived in the private companies/startups.
Discounted cash flows (DCF)
Less used in early stage investing, DCF are calculated based on the sum of all future cash flows that the business will generate, discounted at an expected return rate for the investment. In general, the higher the discount rate, the riskier the investment.
Widely adopted in ‘traditional’ and more established business valuation, this method is way less utilized in Venture Capital since in early stage companies there is little visibility on the behavior of future revenue and costs. The discount rate also has a significant impact on the valuation, which by itself has so many assumptions to be considered that just creates more complexity than clarity.
In summary, a blend between these two methods should give you a pretty good understanding of what your valuation would be. By benchmarking the market transactions and also having some projections about your business growth you get very powerful tools that every entrepreneur should use whenever considering a potential sale, fundraising efforts, or a strategic partnership.
Also - I recently came across an article from Talia Goldberg, a GP at Bessemer (one of the biggest VCs in the world, ~$20bn AUM), in which she describes a very wise approach to the valuation of startups used in almost every investment memos at Bessemer: Scenario Analysis. Basically you define plausible scenarios that could take place and the probability of each outcome - the classic probability thinking mindset (the article is here and the spreadsheet she uses as an example is here)
The reason why I like this method is that it incorporates the unpredictability of outcomes of early stages companies. You can view scenarios in a more tangible way, assigning specific probabilities for each, based on the distribution of outcomes for existing ventures.
Long story short, there’s no easy answer for how much is a startup worth - but I hope I was able to give you a little further clarity and guide you to estimate your valuation in a more structured way.
🎧 Podcast recommendations
▶️ The Drive with Peter Attia: Improving body composition, female-specific training principles, and overcoming an eating disorder | Holly Baxter, APD - Yes, another Peter Attia pod recommendation. Holly Baxter is a beast - please check out her YT. To all my readers that are ladies, please pay attention to the message here: building muscle is essential for female health. Not only about aesthetics, it’s a critical component of a long, healthy, and functional life.
▶️ 20VC: Why 75% of VCs will disappear next year with Kyle Harrison, GP at Contrary Ventures - Building a business is hard, but being an investor is also not an easy task. In an economy of shrinking liquidity and higher returns requirements, running a successful VC firm is not going to be a simple journey in the next few years. Kyle Harrison has plenty of experience in the investment side and gives a good perspective on the “other side of the table” in this conversation with one of my favorite Brits out there, Harry Stebbings.
This is Open Books - a weekly newsletter carefully curated by me, Leticia Souza. Every now and then I’ll be compiling relevant topics around finance and financial strategy - from choosing your first accounting system to how to successfully close a fundraising round for your business.
In a world full of noise, I aim to bring clarity and direction to your finance processes so you can manage your business in peace. If you find the content useful, do your friends a favor, and please share this newsletter with them.
See you next time 👋🏼
Leticia
Nice to see you back! Great thoughts on valuations. Complex topic!