Use the Private Companies Price Index (PCPI) with caution in Business Valuations
Business Valuation Bloopers - just a few of the ways it can go wrong

VALUING START UPS AND EARLY STAGE BUSINESSES

Start up valuationValuations are quantitative and we rely heavily on financial and other numerical inputs.  Not only that valuations get better the more financial information is available.

This is why start-ups and early stage businesses can be difficult to value.  For a valuer there’s a death-zone somewhere between seed funding and the emergence of sustainable financial performance.   As anyone doing business in and around Cambridge will tell you most start-ups have a spell when there’s few reliable numbers to work with.  So how can we value businesses when they’re in the data death-zone?

Comparable Transactions: Of course no two companies are identical but acquisitions of “somewhat” comparable start-ups can provide useful reference points.  Without usable financials we can compare based other metrics – for example IP portfolios, number of subscribers or drug pipelines.  It may feel like horse trading and exact matches are rare, but a couple of close comparables can support a relatively accurate valuation.

Cost Approach:  While some entrepreneurs might not agree, until a company passes a meaningful proof-of-concept milestone, a start-up is valued on a time and materials basis, if that. A potential purchaser might add a premium for timing and the cost of trial-and-error, but will mostly view early stage technology as something they could recreate internally.

Transactions in Start-up’s Own Shares: This is a bit like calculating the market cap of public companies; start-up valuation can be derived from the value of its individual shares. To use this approach one has to assume that the transaction was fairly negotiated at arm’s length and by a professional investor. Not all equity shares are equal and simple multiplication, while widely used, won’t often work. But a well-negotiated funding round can provide a usable value indicator.

Rules of Thumb can sometimes be used, but this is best left for corroboration of other methods.  For example the Berkus Method (invented by US business Angel Dave Berkus) seeks to “price” different qualitative stages of a start up’s development such as having a sound idea, a prototype, or a decent team and ascribing a fixed $500k value to each step.    One could defend this slightly arbitrary approach because if enough business angels use.

Read about our business valuation services

Comments

The comments to this entry are closed.