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If you want to raise startup financing for your business, one of the most important steps is obtaining an accurate valuation. Startup valuations are essential because they are the benchmark investors will use when determining how much to invest in your company. This is the case for both debt and equity financing. Hence, this article will look at how you might value your startup and the legal and commercial implications of business valuations.
What Is a Startup Valuation?
A startup valuation is the process of determining the financial worth or value of a startup company. It is essential because it serves as a benchmark for investors to evaluate how much to invest in the business. Investment in your business may occur through either equity financing or debt financing. Valuations take into account various factors, such as:
- the company’s growth stage;
- financial projections;
- assets;
- market comparisons; and
- potential risks.
Obtaining an accurate startup valuation is crucial for attracting investment and making informed financial decisions.
LegalVision’s Startup Manual is essential reading material for any startup founder looking to launch and grow a successful startup.
Why is a Valuation Important for My Startup?
If you want to raise equity financing by issuing shares to outside investors in exchange for cash, the first question investors might ask is, “How many shares do I get in exchange for my investment?”
For instance, suppose your pre-money valuation is £1m, and your investors are prepared to contribute an additional £1m in equity financing. Issuing investors shares equal to half of your existing outstanding share capital may be a good place to start negotiations. The additional £1m in new investor money is worth half of your startup’s overall value. It follows that your investors expect an equal ownership stake in your business.
Likewise, if you are considering debt financing, lenders or other debt investors need to know what the value of your company is to determine how much to lend. This is also important if the loan will be secured on your startup’s assets. The value of the loan amount will ideally not exceed the value of the secured assets.
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How Do I Obtain a Valuation?
Valuing a business is as much an art as it is a science. That is to say, it is challenging to value startups. This is because startups have little to no track record of previous financial performance. Furthermore, most startups are unlikely to have fully launched their market-ready product or service.
This means that valuation experts have less data and information to interpret. Likewise, the methods used to value larger, more mature businesses are inadequate for startups. Therefore, you will likely want to instruct a financial adviser experienced in valuing startups.
What Are Some Valuation Techniques?
It is essential to appreciate that financial advisers may use different valuation techniques. Likewise, depending on where your company is in the growth cycle, some valuation techniques are more relevant than others. Below are some standard valuation techniques used for startup companies.
| Valuation Technique | Explanation |
| Fixed-stage valuations | Early-stage investors commonly use this approach. Rather than attempt to put a precise value on each target, angel and venture capital investors will make a fixed investment based on where your company is in its growth stage. For instance, a business with a clear business plan but little operational success may only attract between £100,000 and £250,000. However, a startup with a beta product and customer sales may attract between £1m and £5m. |
| Discount cash flow valuation | The discount cash flow valuation forecasts future operating profits (or cash flows). Based on the forecast, the analyst determines how risky investing in your startup is. This figure is then applied against the future cash flows, which reduces their value. The sum of these discounted cash flows is your company’s enterprise value. This figure is then used to determine how much debt or equity to invest. This method is not suitable for early-stage startups that have not yet started generating sufficient sales. |
| Asset valuations | This looks at the value of your startup’s underlying assets to arrive at a valuation figure. For startups with lots of tangible assets like property and machinery, the figure will be higher than a startup with less tangible assets. For instance, a startup with just a business plan has very little tangible asset value. |
| Entry valuations | Entry valuations ask how much money it would cost to replicate your business as it currently is. This technique assumes that an investor will not spend more than this. For instance, if your startup is developing a new software application, the investor might ask how many programming hours your business has undertaken. It then uses this figure to value your company. |
| Market multiple valuations | This looks at what similar businesses have sold for or raised in financing. It might then account for differences between you and the other companies. This approach relies upon historical data and requires enough information to compare your startup to others. Therefore, the earlier in the growth stage your company is in, the less relevant the market multiple is. This is because market multiples rely on relationships between certain performance metrics like sales and market conditions. |
Legal and Commercial Considerations During Startup Valuation
It is essential to remember that different analysts may come up with wildly different valuation models. This is based on different:
- assumptions;
- modelling techniques; and
- negotiating positions.
As a founder, you will likely come to the table with a higher valuation than an investor. Usually, investors have the upper hand. Therefore, you should be prepared to enter into a financing agreement that values your startup for less than what you think it is.
Additionally, as with all financing negotiations, your investors rely on you to make faithful and factually true statements when valuing your business. Suppose you disclose information that is not factually accurate, even if by accident. In this instance, you and your business can be liable.
Key Takeaways
Obtaining an accurate valuation is essential when raising startup financing. It determines the investment amount for both equity and debt financing. However, valuing startups is challenging due to limited financial data and unproven concepts. Financial advisers use different valuation techniques depending on your startup’s growth stage. Founders should also anticipate lower valuations during negotiations and provide accurate information to limit liability during the financing process.
If you need help with your startup, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Valuations are crucial as they determine the investment amount and ownership stakes for equity financing and help lenders assess loan amounts and secured assets for debt financing.
Standard valuation techniques for startups include fixed-stage valuations based on the growth stage, discount cash flow valuations that assess future cash flows, asset valuations based on your startup’s underlying assets, entry valuations replicating the business’s current cost, and multiple market valuations based on similar businesses.
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