As in the previous article, I have already discussed the Stages of Startup Funding, https://taxconcept.net/demystifying-startups/ (link to the article) in this article we will discuss the Valuation of Startups in different Stages.
Generally, a Startup goes through 3 stages namely:-
- Early Stage
- Growth Stage
- Late Stage
- Early Stage:- It is the stage where the founder has an idea of the business he wants to start. The early stage begins with a potentially scalable idea for a product or service targeting a market that is poised to generate value. They have a limited team and prototype and they make continuous changes to make it a perfect market fit. They will test their product/ service with the users, to ensure that it is accepted by the users in the market.
- Growth Stage:- It is the stage where the product/service reaches a wide number of users. They spend more money on Marketing and Advertising to get a wider reach. It is the stage where the product service is accepted by a wide range of users and there would be tremendous growth in the business. There would be exponential growth in their Sales, Valuation, and Traction. It is the stage where the company seeks series A funding from Venture capitalists as they achieved a certain growth in their business.
- Late Stage:- It is the stage where the startup reaches a certain maturity. Users would frequently use the product/service as they get used to it. It is the stage where the company would be planning for IPO and the investors would be planning for exit opportunities. The company would be looking for expansion opportunities as they have grabbed customers in a specific sector or location.
Now, we would look into the valuation methods suitable for each stage:-
- In the early stage, the investor generally invests or has trust in the founder and product/service rather than in the sales generated as it is in the early stages and yet to be launched in the market. So, the suitable method that can be used for valuing a startup at this stage would be the Transaction Comparable method.
In this method, they value the startup by looking into a similar private company and using different key financial ratios, so they can arrive at a correct and fair value in the early stage which would be accepted by the founder.
- In the growth stage, it is the stage where the company reached a certain maturity and grows exponentially, and establishes a market fit for the product or service. So the suitable method in this stage can be Revenue or Profit multiple.
In this method, if we consider Revenue multiple it is derived by dividing the Market value of the company by annual revenue. This method is generally used by Startups that are not yet profitable and have high growth potential
Another method namely the profit multiple approach used to value Startups based on their expected earnings or profits. This method takes into account the projected future profit of the business and uses a multiple to calculate the startups’ value. The multiple is typically based on industry benchmarks or comparable valuations of similar startups.
For example, if a Tech startup s projected t have earnings of Rs. 7,00,000 next year and the industry benchmark multiple is 5x earnings, the value of the startup based on the profit multiple approach would be Rs. 3.5 million ( 5 times Rs. 700000).
- In late stage Startup valuation, typically refers to the stage where it has gone through several rounds of funding and has a proven business model and significant revenue and customer base. Late-stage startups may also have significant competition and also may be focused on scaling their operations and expanding their market share.
The most comment method used during this stage can be Discounted Cash flow method. This method uses expected future cash flow to determine the value of an investment. The value of the business is the sum of all future cash flows, discounted back to their present value.
However, it’s important to note that the valuation of startups is complex and can involve multiple methods and calculations. The above-given methods are just a few approaches for startup valuation. Other methods may include Cost-to – Duplicate approach, Market multiple approach, and Berkus approach…etc.