By Peter Haley
Start-ups are new businesses, potentially fast growing that are aiming to fill a hole (which they may create) by offering a unique product, process or service.
In our valuation practice we are currently seeing more and more start-ups and businesses that don’t have tangible assets, a proven track record or sometimes even a proven business case. What they all have though is current owners who believe they are sitting on the next big thing.
Business valuation is never straightforward.
With a mature, established business the business valuer usually uses the historical trading performance as the starting point for estimating the future trading performance. However for start-ups with little or no revenue (let alone profits) and potentially an uncertain future valuation is more art than science.
The purpose of a valuation is to work out what something is worth. The most common standard of value is ‘market value’ which defines value as: The price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller, acting at arms-length.
Value can also be defined as: The amount a prudent investor is willing to pay to receive the future returns, having regard to risk (whilst noting that price is what is paid, value is what it is worth).
Any business valuation has the following primary drivers:
- Risk (including size, competition, economic and industry, operational, key employee and financial)
- Core assets (working capital and infrastructure)
- Profitability / cashflow (the past is not necessarily representative of the future – what has changed? What could change?)
The fundamentals of valuation don’t change whether it is a start-up or established business and the following “traditional” valuation methodologies are employed in valuing start-ups:
- Discounted cash flow – however major difficulty is estimating the future cash flows
- Book value – what has it cost to get where you are today? Assumes an investor would not pay any more than it would cost them to replicate work to date
- Liquidation value – constituting the scrap value of the tangible assets. This may be very little for a start-up that is developing intellectual property (IP) which is intangible and is not yet proven.
As “traditional” valuation methodologies are often considered not appropriate several ‘rule of thumb’ valuation methodologies have evolved to value start-ups. These typically are used in valuing pre-revenue start ups and involve subjective rating against criteria or risk factors and involve measuring against a base or comparable business. Finding a base or comparable business is often difficult.
No matter if you are valuing a start-up or an established business it is essential to recognise it is all about the future and perceptions of the future can change significantly in short periods of time. Further, regardless of the level and quality of the investment in an infrastructure or operating platform, value is all future returns – without returns, finding value is difficult.
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