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Investing in Startups
Considerations & Valuations
August 2018 Ajay Arora
Why Invest in Startups
 Strategic – Invest in upcoming technologies (for captive use);
keep abreast of updates in the field that one operates in
 Financial – Be an early investor; reap the returns as it matures;
Softbank &Yahoo made a fortune by investing in Alibaba
 Promote Entrepreneurship – incubate and nurture the business ideas
Deciding Parameters – Positive
 Industry Attractiveness/Business Idea – Problem being addressed by
theVenture
 Promoters Reputation – Track record of coming up with good ideas or
running successful businesses
 Scalability, Traction – among customers & future roadmap
 Proof of Concept – Prototype (or actual product) which displays the
product/service
 Supply and Demand – Not just of the offerings of the venture, but also
Capital (investors & similar businesses)
 Distribution Channel – online, offline and/or hybrid
o Poor Industry – If a startup is in an industry that has shown poor performance, or
may be dying off
o Low Margins – Some startups will be in industries, or sell products that have low-
margins, making an investment less desirable
o Competition – Some industry sectors have a lot of competition, or other business
that have cornered the market
o Management Not UpTo Scratch – If the management team of a startup has no
track record or reputation, or key positions are missing
o Product – If the product doesn't work, or has no traction and doesn't seem to be
popular or a good idea
o Desperation – If the business owner is seeking investment because they are close to
running out of cash
Factors which are detrimental
o Unit Economics - Positive Unit economics (i.e., margin per order) help
o Existing/Other Investors – Interest level of other investors
o Stage of Startup – Late stage and/or Mature startups raising funding (Series C, D or
later) are likely to command a premium valuation (if their track record has been good) as
compared to the ones seeking early stage/angel rounds
o Exit – How easy is the exit for Investors & the (likely) timelines & valuation
Other factors impacting the decision
Valuation Methodologies
Venture Capital (VC) Method
VC Method works on the concept of likely ROI determining the current valuation
Hence
 Return on Investment (ROI) = Terminal (or Harvest)Value ÷ Post-moneyValuation
 Post-moneyValuation =TerminalValue ÷ Anticipated ROI
 Pre-moneyValuation = Post money valuation – Investment consideration
Terminal (or Harvest) value is the startup's anticipated selling price in the future,
estimated by using reasonable expectation for revenues in the year of sale and
estimating earnings. It is determined by
TerminalValue (nth year) = Projected Revenue (in nth year)/Revenue Multiple
Revenue Multiple is given byValuation of Reference company/Revenue of target at the time of
funding
Berkus Method
The Berkus Method assigns a range of values to the progress startup business owners
have made in their attempts to get the startup off of the ground.
Typically used for Pre-Revenue startups
Factor, if it exists Add to CompanyValue up to
Sound Idea
(basic value)
$ 0.5 million
Prototype
(reducing technology risk)
$ 0.5 million
Quality ManagementTeam
(reducing execution risk)
$ 0.5 million
Strategic relationships
(reducing market risk)
$ 0.5 million
Product Rollout or Sales
(reducing production risk)
$ 0.5 million
Scorecard Valuation Method
The Scorecard Valuation Method uses the average pre-money valuation of other
seed/startup businesses in the area, and then judges the startup that needs valuing
against them using a scorecard in order to get an accurate valuation
 The first step is to find out the average pre-money valuation of pre-revenue
companies in the region and business sector of the target startup
 The next step is to find out the pre-money valuation of pre-revenue companies
using the Scorecard Method to compare.The scorecard is as follows:
 Strength of Management/Founding Team : 0-30%
 Size (of Opportunity) : 0-25%
 Product/Technology : 0-15%
 Competitive Environment : 0-10%
 Marketing/Sales Channels/Partnerships : 0-10%
 Need For Additional Investment : 0-5%
 Other factors (say early customer feedback) : 0-5%
 The final step is to assign a factor to each of the above qualities based on the target
startup and then to multiply the sum of factors by the average pre-money
valuation of pre-revenue companies
Most Commonly used valuation method
 Comparable and a Rough estimate of how much
dilution is acceptable by the founders  is most
commonly used
e.g. giving out 15% to 25% for a seed round comprised between $ 0.3
million and $ 0.5 million or making sure that the founders remain
majority shareholders after Series A
 Valuations are thus largely the ‘Guesstimates’
 The best valuation method is the one takes into
account defining the need of the founder and the
company and then deciding/negotiating dilution
The optimal amount raised is the maximal amount which, in a given
period, allows the last penny raised to be more useful to the company
than it is harmful to the entrepreneur
Happy to Help
aroraajay@gmail.com
https://in.linkedin.com/in/arorajay
Handphone: +919911108933

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Startup valuation methods

  • 1. Investing in Startups Considerations & Valuations August 2018 Ajay Arora
  • 2. Why Invest in Startups  Strategic – Invest in upcoming technologies (for captive use); keep abreast of updates in the field that one operates in  Financial – Be an early investor; reap the returns as it matures; Softbank &Yahoo made a fortune by investing in Alibaba  Promote Entrepreneurship – incubate and nurture the business ideas
  • 3. Deciding Parameters – Positive  Industry Attractiveness/Business Idea – Problem being addressed by theVenture  Promoters Reputation – Track record of coming up with good ideas or running successful businesses  Scalability, Traction – among customers & future roadmap  Proof of Concept – Prototype (or actual product) which displays the product/service  Supply and Demand – Not just of the offerings of the venture, but also Capital (investors & similar businesses)  Distribution Channel – online, offline and/or hybrid
  • 4. o Poor Industry – If a startup is in an industry that has shown poor performance, or may be dying off o Low Margins – Some startups will be in industries, or sell products that have low- margins, making an investment less desirable o Competition – Some industry sectors have a lot of competition, or other business that have cornered the market o Management Not UpTo Scratch – If the management team of a startup has no track record or reputation, or key positions are missing o Product – If the product doesn't work, or has no traction and doesn't seem to be popular or a good idea o Desperation – If the business owner is seeking investment because they are close to running out of cash Factors which are detrimental
  • 5. o Unit Economics - Positive Unit economics (i.e., margin per order) help o Existing/Other Investors – Interest level of other investors o Stage of Startup – Late stage and/or Mature startups raising funding (Series C, D or later) are likely to command a premium valuation (if their track record has been good) as compared to the ones seeking early stage/angel rounds o Exit – How easy is the exit for Investors & the (likely) timelines & valuation Other factors impacting the decision
  • 7. Venture Capital (VC) Method VC Method works on the concept of likely ROI determining the current valuation Hence  Return on Investment (ROI) = Terminal (or Harvest)Value ÷ Post-moneyValuation  Post-moneyValuation =TerminalValue ÷ Anticipated ROI  Pre-moneyValuation = Post money valuation – Investment consideration Terminal (or Harvest) value is the startup's anticipated selling price in the future, estimated by using reasonable expectation for revenues in the year of sale and estimating earnings. It is determined by TerminalValue (nth year) = Projected Revenue (in nth year)/Revenue Multiple Revenue Multiple is given byValuation of Reference company/Revenue of target at the time of funding
  • 8. Berkus Method The Berkus Method assigns a range of values to the progress startup business owners have made in their attempts to get the startup off of the ground. Typically used for Pre-Revenue startups Factor, if it exists Add to CompanyValue up to Sound Idea (basic value) $ 0.5 million Prototype (reducing technology risk) $ 0.5 million Quality ManagementTeam (reducing execution risk) $ 0.5 million Strategic relationships (reducing market risk) $ 0.5 million Product Rollout or Sales (reducing production risk) $ 0.5 million
  • 9. Scorecard Valuation Method The Scorecard Valuation Method uses the average pre-money valuation of other seed/startup businesses in the area, and then judges the startup that needs valuing against them using a scorecard in order to get an accurate valuation  The first step is to find out the average pre-money valuation of pre-revenue companies in the region and business sector of the target startup  The next step is to find out the pre-money valuation of pre-revenue companies using the Scorecard Method to compare.The scorecard is as follows:  Strength of Management/Founding Team : 0-30%  Size (of Opportunity) : 0-25%  Product/Technology : 0-15%  Competitive Environment : 0-10%  Marketing/Sales Channels/Partnerships : 0-10%  Need For Additional Investment : 0-5%  Other factors (say early customer feedback) : 0-5%  The final step is to assign a factor to each of the above qualities based on the target startup and then to multiply the sum of factors by the average pre-money valuation of pre-revenue companies
  • 10. Most Commonly used valuation method  Comparable and a Rough estimate of how much dilution is acceptable by the founders  is most commonly used e.g. giving out 15% to 25% for a seed round comprised between $ 0.3 million and $ 0.5 million or making sure that the founders remain majority shareholders after Series A  Valuations are thus largely the ‘Guesstimates’  The best valuation method is the one takes into account defining the need of the founder and the company and then deciding/negotiating dilution The optimal amount raised is the maximal amount which, in a given period, allows the last penny raised to be more useful to the company than it is harmful to the entrepreneur