How does company valuation work

You have been successfully registered for our daily newsletter. Traction is a sign that your company is taking off. Traction is basically quantitative evidence of customer demand. You can always get more traction. Out of all things that you could possibly show an investor, traction is the number one thing that will convince them.

Even though your product might be in very early stages, you might already have a distribution channel for it. This will help a lot for the VCs to get to know what the startup is and can become the turning point of the decision of that investor. This Method is the most usable and appropriate method to value the company in the initial stage. The discounted cash flow method takes free cash flows generated in the future by a company and discounts them to derive a present value i. This Method mainly depends on the free cash flows that you are going to earn in the future and affected by the various factors which includes the inflations and unstabilities that will come in the market at the future stage.

The venture capital method reflects the process of investors, where they are looking for an exit within 3 to 7 years. First an expected exit price for the investment is estimated. From there, one calculates back to the post-money valuation today taking into account the time and the risk the investors takes.

The market comparables method attempts to estimate a valuation based on the market capitalization of comparable listed companies. In part 6, we talked about the process of raising a real series A round , serious money.

There are plenty of articles out there that will talk about the math and the finer details surrounding calculating a company valuation for your startup when raising money. I want to discuss how startup valuation works, how should be thinking about valuation in general and what it means for you now and down the road. Simply put, the value of your company is an agreement between you and your potential investors of that value, not that different from valuing a house.

Yes, there are algorithms and models for valuing revenue, profit, customer lists and the like, but ultimately it will come down to a negotiation and an agreement, so keep your expectations realistic and remain flexible during this process. Consider the result of such a model as just a starting point for establishing value rather than an actual number to use as leverage during negotiations. Pick your battles wisely, be aware of whatever leverage you do have if any , and play your cards right for long term success more on this in a moment.

Funny enough, you can actually get a higher company valuation before you ship anything because it is all speculation. Once you ship, everything changes and becomes measurable where pre-shipping valuations are much more subjective.

Ultimately, as with any negotiation, it will come down to how bad they want to invest and what other options you have. Absolute valuation models attempt to find the intrinsic or "true" value of an investment based only on fundamentals.

Looking at fundamentals simply means you would only focus on such things as dividends, cash flow, and the growth rate for a single company, and not worry about any other companies. Valuation models that fall into this category include the dividend discount model, discounted cash flow model, residual income model, and asset-based model.

Relative valuation models, in contrast, operate by comparing the company in question to other similar companies. These methods involve calculating multiples and ratios, such as the price-to-earnings multiple, and comparing them to the multiples of similar companies. Typically, the relative valuation model is a lot easier and quicker to calculate than the absolute valuation model, which is why many investors and analysts begin their analysis with this model.

The earnings per share EPS formula is stated as earnings available to common shareholders divided by the number of common stock shares outstanding. EPS is an indicator of company profit because the more earnings a company can generate per share, the more valuable each share is to investors. There are various ways to do a valuation. The discounted cash flow analysis mentioned above is one method, which calculates the value of a business or asset based on its earnings potential.

Other methods include looking at past and similar transactions of company or asset purchases, or comparing a company with similar businesses and their valuations. The comparable company analysis is a method that looks at similar companies, in size and industry, and how they trade to determine a fair value for a company or asset. The past transaction method looks at past transactions of similar companies to determine an appropriate value. There's also the asset-based valuation method, which adds up all the company's asset values, assuming they were sold at fair market value, to get the intrinsic value.

Sometimes doing all of these and then weighing each is appropriate to calculate intrinsic value. Meanwhile, some methods are more appropriate for certain industries and not others. For example, you wouldn't use an asset-based valuation approach to valuing a consulting company that has few assets; instead, an earnings-based approach like the DCF would be more appropriate. Analysts also place a value on an asset or investment using the cash inflows and outflows generated by the asset, called a discounted cash flow DCF analysis.

These cash flows are discounted into a current value using a discount rate, which is an assumption about interest rates or a minimum rate of return assumed by the investor. If a company is buying a piece of machinery, the firm analyzes the cash outflow for the purchase and the additional cash inflows generated by the new asset. All the cash flows are discounted to a present value, and the business determines the net present value NPV.

First, you find the average pre-money valuation of comparable companies. Do this for each startup quality and find the sum of all factors. Finally, multiply that sum by the average valuation in your business sector to get your pre-revenue valuation. The key to this method is in the name. You simply add up the fair market value of your physical assets.

You may also include research and development costs, product prototype costs, patent costs, and more. This is a broader method of valuing your startup. Start with an initial valuation based on one of the other methods mentioned here.

The difficult portion of this method is finding an objective point of reference to measure each component. Starting with comparable methods, like the Scorecard Method or Comparable Transactions Approach, may help. You may need to work closely with a market analyst or an investor to use this method. You take your forecasted future cash flows and then apply a discount rate, or the expected rate of return on investment ROI.