Steps for VC to value a start-up - Examples

Many Founders are not clear on how does a VC value a start-up . I am sharing a simple example.

In this post, I will talk about the most common VC Valuation Approach which is called Venture Capital Method, developed by Bill Sahlman.

There are other methods as well for valuing startups like-

- Berkus Method

- Scorecard Valuation Method

- Comparable Transactions Method

- Cost to Duplicate Approach

- Risk Factor Summation Method

- DCF Method/ First Chicago Method

- Book Value Method

Among these, the Venture Capital method is a go-to for venture capital firms, and it's another option to consider if you need a pre-revenue valuation.

It also reflects the mindset of investors who are looking to exit a business within several years.

Venture Capital Method comprises 6 steps:

1. Estimating Capital Requirements of the start-up

2. Financial forecasting

3. Timing of VC Exit

4. Multiple at Exit

5. Desired Rate of Return of VC

6. Ownership Stake of VC

Example:

- Suppose a start-up is looking to raise $5 M and it has a total of 1 million shares outstanding

- Based on the Financial forecasting, the start-up’s EBITDA after year 5 is $12m

- VC Firm will exit after year 5

- EBITDA Multiple= 7

- Start-up Value at Exit= $12m*7= $84m

- Next, let’s consider the VC Firm’s desired rate of return= 30%

- Future value of Investment= $5m* (1+30%)^5= $18.6m

- Required Ownership by VC Firm= $18.6m/ $84m= 22.1%

- Post-money Valuation of the company= $84m/ (1+30%)^5= $22.6m

- Pre-money Valuation of the company= $22.6m- $5m= $17.6 M

- Total number of shares outstanding= 1m

- Share Price= $17.6m/ 1m= $17.6

- Total number of Shares Post-money= $22.6m/ $17.6= 1.28 M

If you have come this far, here is some more information about valuation.

It is important for entrepreneurs to know at which stage their startup is.

Depending on the stage of the startup, the founders can expect lower or higher offers from the investors

- Startup Stage- Concept/ Business Plan

- Investors- Self or Family & Friends

- Valuation- $250K to $1m

- Stage- Technology Developed

- Investors- Angels, Seed VCs

- Valuation- $1m to $5m

- Stage- Launch/ Early Customer Traction

- Investors- Seed VC, Series A VC

- Valuation- $5m to $15 m

- Stage- Scaling & Adoption (cash flow negative)

- Investors- Series A/B/C VC

- Valuation- $15m to $30 m with outliers to $100m

- Stage- Rapid/ Mass Expansion (cash flow positive)

- Investors- IPO or Exit

- Valuation- $100m to $1 b, average IPO of $500m

Believe this will give you an excellent idea about startup valuation.

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Glossary:

Start-up: A newly created company that is still in the early stages of development and growth.

Financial forecasting: The process of predicting a company's future financial performance based on historical data and other factors such as market trends and industry outlook.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): A measure of a company's profitability that calculates earnings before deducting interest expenses, taxes, depreciation, and amortization.

VC Firm (Venture Capital Firm): An investment firm that provides funding to startups and early-stage companies in exchange for ownership stakes.

Exit: An event in which a VC firm sells its ownership stake in a company, either through an initial public offering (IPO) or through a merger or acquisition.

EBITDA multiple: A valuation ratio that measures a company's value based on its EBITDA.

Post-money valuation: The valuation of a company after a new investment has been made.

Pre-money valuation: The valuation of a company before a new investment has been made.

Shares outstanding: The total number of shares of a company's stock that have been issued and are held by investors.

Share price: The price per share of a company's stock.

Self or Family & Friends: These are typically the initial investors in a startup, and are usually people with a personal connection to the founders.

Angels: High net worth individuals who invest in startups in exchange for equity.

Seed VCs (Venture Capitalists): Investment firms that provide funding to startups in exchange for equity.

Series A/B/C VC: These are later-stage venture capital firms that provide funding to startups as they grow and develop.

IPO (Initial Public Offering): The first time a company's stock is offered for public sale, allowing the general public to invest in the company.

Valuation: The process of determining the value of a company or asset based on various factors such as financial performance, market conditions, and industry trends.

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Some more examples: 

Example 1: Zoom Video Communications Inc.

Zoom Video Communications Inc. is a California-based video communications company that offers video conferencing, chat, and webinars. In January 2017, the company raised $100 million in a Series D funding round led by Sequoia Capital at a valuation of $1 billion. The company had 250,000 customers and was generating revenue of $60 million at the time.

In April 2019, Zoom went public and raised $751 million in its initial public offering (IPO) at a valuation of $9.2 billion. The company's shares opened at $65 each, well above the initial pricing range of $28-$32. The IPO was oversubscribed, and the company's shares surged more than 80% on the first day of trading.

Example 2: Coinbase Global Inc.

Coinbase Global Inc. is a cryptocurrency exchange that allows users to buy, sell, and store digital assets such as Bitcoin, Ethereum, and Litecoin. In 2012, the company was founded in San Francisco, California, and raised $5 million in a Series A funding round led by Union Square Ventures and Ribbit Capital.

In April 2021, Coinbase went public and raised $1.25 billion in its IPO at a valuation of $85.8 billion. The company's shares opened at $381 each, well above the initial pricing range of $250-$350. The IPO was the largest direct listing in history, and the company's shares surged more than 30% on the first day of trading.

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