Fundraising is an vital part of any startup’s journey. To create a successful business story, startups must go through multiple fundraising rounds: preseed, seed, and series rounds. Today, fundraising is crucial for the continued growth of an operation in a saturated market. Insufficient funds can lead to problems for the business and make the journey difficult. In addition, market uncertainties and technological advances have made it difficult for early-stage startups to survive.
In such a dynamic environment, fundraising is essential to remove any stumbling blocks in business operations. To attract investors, founders of startup companies need to conduct detailed valuations. This will allow them to make informed decision about whether to invest or not.
Understanding startup valuation
Startups must determine how much capital they will need to be eligible for funding from other sources like angel investors, VCs, and a group of investors. Startup valuation means determining the startup’s worth or idea. Startup valuation is an essential part of any fundraising effort. When investors invest in a startup, they exchange components of the equity. Startup valuation is crucial. The process of valuation eliminates guesswork and gives the startup its estimated value.
A lot of new founders don’t have the necessary knowledge to evaluate startups properly. Even when they are still in a pre-revenue generation, some founders quote high figures to investors. Many founders will quote a lower price if their idea is a winner and can disrupt the market. Understanding the fundamental methods of startup valuation is crucial.
Methods of startup valuation
Particularly for startups in their pre-revenue phase, valuation is essential. These startups don’t usually have any concrete facts or figures on which to base their valuation. This is why predefined valuation methods are necessary.
These are few most prominent methods for startup valuation:
Berkus method: This method is developed by Dave Berkus, an American venture capitalist. This method assigns $0.5 million to different factors as the startup progresses. It focuses on five key elements: sound ideas, prototype, quality, and strategic relationships with management, as well as product rollout or sales. The startup value can range from $0-2.5million. This method can only be used for pre-revenue companies.
Scorecard method This uses the value assigned to an angel-funded business. The process begins by finding a company operating in the same region and domain as yours. After determining the average pre-money valuation for that company, the startup is thoroughly analyzed to determine its strengths and limitations. It is evaluated based on many factors, including the opportunity’s size, technology/product, management strength, and competitive environment. Funding requirements are also considered.
Risk factor summation method: This method is a combination of Scorecard and Berkus, emphasizing the risks. To assign grades to each category, there are several types of risk associated with the investment. Several risk categories can be categorized. These include management, stage, marketing, sales, and funding requirements.
Venture capital is a method of investing: This startup valuation method emphasizes exit or the terminal worth of the startup. Investors consider the startup’s future returns when valuing startups. This method is one of the best and most accurate. It makes it easier for investors to estimate potential exit values once certain milestones have been reached.
The First Chicago method this method was initially developed by the First Chicago Bank’s venture financing arm. This method is used by private equity and venture capital investors. First, Chicago helps investors understand the feasibility and ambition of a startup’s plan by combining elements of multiple-based valuation with cash flow-based methods. This method considers three different scenarios: normal, best, and worst.
The proper method for startup valuation is beneficial to both the founder and the investor. It gives a great idea of the company’s assets, resale, and actual value. It also helps in mergers and acquisitions and raises funds to achieve the company’s plans and goals.