Startup valuation is a technical process whereby the investors who are looking to buy a business do a thorough business valuation of the marketable value of a business.
In the public markets, that valuation is obviously much easier … you can determine the value of any publicly-traded company by searching their stock and market value, and can have that info in less than one minute. Do a quick search of “value of Apple“, and you’ll know how much Apple is worth very quickly.
Unfortunately, in the small and medium business market, and where there’s no public valuation of the worth of a business, there are many variables that need to be considered.
The trick from a small business perspective is to come up with a business’s value so that both the seller and the buyer, are comfortable with the valuation.
And for that reason, startup valuation especially is a bit different than that of valuation of a mature small or medium company would be.
Startups involve more uncertainty and higher risk while at the same time, have potentially outsized returns. So, a startup’s financial data is important, but along with financial status, you must also consider the other qualitative and quantitative aspects of your business.
In case you’re wondering, and before we dive into how investors value a startup, I found this article on small and medium businesses (SMB) to be particularly helpful in defining what small and medium businesses are and what kind of benefits they have.
So on that note, if you’ve started a small business, and you’re wondering how investors might value your company, then let’s dive in.
5 Ways that Investors Value a Startup
How do startup valuations work?
This article will discuss all those factors that investors consider to determine the value of a startup.
1- The Idea:
The first thing investors look for in a startup is the idea behind the business model. There are hundreds of lucrative small business ideas, but not all of them are attractive to startup investors. So, to make it convincing for the investor, you must identify the problem that your startup solves and explain how exactly it does so.
2- The Market Size:
In market size, the investor actually sees the opportunity. The bigger the market size you have, the faster investors will credit the amount. However, money should also come faster if your product is highly valuable to a smaller segment, but has a high demand. In other cases, if it’s one of the best business ideas, but your numbers are not impressive in terms of initial customer acquisition, the investor will take their time or you may also get an instant rejection.
3- Competition:
How many competitors are there and where do they stand? Why should the investor invest in a startup owned by you and not in your competitor’s? How tough will the competition be in one year, five years, and so on?
This is to be dealt with strategically in your business plan. You must figure out the competitive advantage first and then mention it explicitly in your business plan.
4-The Stage of Development:
The development stage of a startup is important for investors, and this is the part where they spend more time doing due diligence before investing in a startup. Maybe no one was interested when it was in ideation, but as soon as you got a beta product, it started attracting attention. Analysis of the development stage, startup growth strategy, partnerships in place, resources, and funds needed must be the part of the business plan that you will use to pitch to the investors.
5- The Team:
Yes, it matters for the investors. They do consider the potential and achievements of the team. After all, they want to be sure that their money is in the right hands. So, make sure to include an impressive startup team section in the business plan for investors. If it’s the first venture of the team and no one has an achievement yet, you may include the details of your university projects, volunteer work or something where you gave back something to the community!
The Bottom Line on Valuing a Startup
The above-discussed elements are the crucial points that must be communicated clearly and effectively in the business plan, however, you may need to add more resources if you are targeting first-time startup investors.
And then, and most importantly, don’t lose sight of the fundamentals of starting a business which is – focus on the marketing, watch your cash flow, and build a solid team of dedicated, and hardworking individuals. And then, keep in mind, you’re not building a business for investors, you’re building a business for long-term sustainability and profitability. Many small business owners forget that. They’re so focused on the “valuation” that they lose sight of the business itself.
Once you understand how investors value a startup, you’re potentially on your way to earning your first million.
