The common belief is that startups are viewed as successful based on their company valuation. But why do you need to value a private company?
The short answer is that you do not need to value your company until required by a corporate transaction, including taking on investment, starting an employee participation plan, etc.
There a few methods for calculating a company valuation for startups:
1. The Berkus Approach: Created by American venture capitalist and angel investor Dave Berkus, this method looks at valuing a startup based on a detailed assessment of five key success factors:
- Basic Value
- Strategic Relationships in the Core Market
- Production and Consequent Sales.
A detailed assessment is carried out evaluating how much value the five key success factors in quantitative measure add up to the total value of the enterprise. Based on these numbers, the startup is valued.
2. The Cost-to-Duplicate Method: This is used more often in the early stages because the valuation is based on barriers to entry and how much it will cost someone to copy your business. This does not officially include intangible assets, like your brand or goodwill (i.e. if Elon Musk said he is building something, it likely has intangible value due to his brand/history).
To use this method, a business will add up the fair market value of physical assets, research and development costs, product prototype costs, patent costs, etc. This method inherently doesn’t capture the full value of a company because it misses the founder’s engagement and customer engagement.
3. The Comparable Transactions Method: This method uses comparable transactions to view current market value of a business. Founders often will pick one or two recent competitors as the benchmark and compare their similar business metrics like users, advertising revenue, subscription services, bookings, or other metrics that are relevant.
For example, if a company was worth $10M and they have $500k in profit and $100k users while your business has $100k profit and 20k users you can say your company is worth $2M.