Tuesday, December 13, 2011

Valuing Your Early-Stage Company

Before you give or sell equity in your business to anyone, you need to determine how much it’s worth. This can be especially difficult if your company has no historical financials or earnings. Below are some of the most common valuation strategies:

  1. Book Value: This form of valuation is practically worthless for startups because it is determined by the value of the assets your business has. For startups, this is often nothing or very little, so I don’t recommend using or even considering book value for early-stage companies.
  2. Market Comparables: For startups, in order to use market comparables, you will need someone to tell you how much they got for their business (unless it’s a public company, in which case all contracts must be disclosed in the financials and filings). When using public trading comparables to value your start-up, just be sure to realize that public companies are valued much higher than private, early-stage companies because they are much more liquid and easy to get in and out of your investment.
  3. Earnings Multiples: Privately held companies can be worth anywhere between 4-7x profits, whereas publicly held companies can often trade in the 10-50x profits (Price-to-Earnings)
  4. Present Value of Future Earnings: For this methodology, you will need your financial projections for at least the next two to three years. Then, you basically take your future earnings and discount them (often based on a discount rate as high as 25-35%+) in order to get the present value of your company. You want to be realistic with your financial projections, but you have to also take into consideration that investors will discount your financial projections either way.
Valuation and determining the financial projections of companies is one of the areas that I've had a lot of experience with, so if you have any questions specific to your company, feel free to follow up.

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