Home Professionalisms The Value Of Knowing A Startup’s Worth

The Value Of Knowing A Startup’s Worth

535
0

by Kemp Moyer, Director, Advisory at BPM

Nearly 15 years ago, two San Francisco roommates were looking for ways to cover their rent. On a whim, they decided to try and rent out air mattresses in their apartment when a large convention came to town, and all the hotel space was booked. Shockingly, this new service, which they called Air Bed and Breakfast, was a success. Over the next few years, their startup expanded and refined the idea and built a solid international customer base before finally going public in December 2020. The company, now named Airbnb, has a market cap of around $106 billion. That’s larger than the market caps of Marriott International and Hilton Worldwide combined.

Today, all across the United States and the world, thousands of tech startups hope to follow in Airbnb or another tech giant’s footsteps. They are all looking for investors who can help provide the capital to grow the business. At the same time, they keep an eye on the possibility of a future successful IPO to become the next DoorDash or Spotify. Other possible exit strategies include being taken to market in a reverse IPO via a SPAC or purchased by a private equity firm or a larger rival.

Startup Valuations

As with Airbnb, it can take time for a startup to grow. Going beyond seed funding or the angel investor stage is a challenge. Startup technology companies take time and significant capital before they can become cash-flow positive. However, companies that have developed a supportable valuation can find it helpful to attract a new round of investors and find a mutually beneficial deal. It is also critical to have a fair market value for tax purposes when or if the company issues options to management and key employees. It is also essential that the company update this valuation after each round of funding.

There are a few ways to calculate a startup’s value, but the three most common methods are here.

Cost-to-Recreate Valuation: This is often the most simplified valuation method. This approach looks at what it would cost to build an identical company from the ground up. It involves getting a fair market value for everything the company owns, from office equipment to inventory. This would include things like the time it took to create the application, research and development, and even the cost of getting a patent for a software startup. This method may not make sense for companies beyond the very early stage, due to the challenge in capturing intangible value. However, it is often viewed as a starting point and can be beneficial for tax compliance purposes.

Market Approaches: Another method to quantify the value of a maturing startup is by looking for comparable companies in terms of product, target market or delivery method. This is accomplished by analyzing public companies that offer a similar product or service or sell to the same type of client or consumer and evaluating the multiples in the industry. Additional data points may potentially arise from an analysis of similar transactions in the M&A space. These approaches often require significant forecasting of the startup’s potential sales, including developing support for the business’s total addressable market and market share assumptions. The challenge with market methods for very early-stage companies is that the data sets are often based on more established companies. Thus, there is often a high degree of forward projection, which can be quite speculative. This also requires significant research and support to ensure the valuation holds up when diligence takes place for a new funding round.

Valuations After Early-Stage Priced Funding: It becomes easier to form the value of a startup and its equity classes after the company has received a priced round of funding. The Series A (or Seed, B, C, Etc.) funding provides an implied value, and the closer in time the valuation is to this round (barring substantial positive or negative news), the more the indicated price of any equity class will gravitate to the indication of value provided by the round. However, over time, the prior funding round gradually loses its place as foundational for updated value, especially as new facts and trends emerge. For instance, is the company generating sales greater than past projections or falling short of forecasts? Has the broader market provided a substantial boost to multiples, or are we facing a bear market? Even if a priced round has been completed at some past date, refreshed analysis and analytics to develop an updated value indication becomes increasingly necessary as time progresses.

Lean on Your Advisors

Depending on the purpose of the valuation, there are nuances to developing a valuation for a startup. If the company is looking to raise equity, the natural desire is for a high valuation. Conversely, if the startup is issuing options, it might be beneficial to have the common equity valuation lower, to reflect the risk inherent in the long horizon to liquidity and more junior equity class. Given the nuance in the process, it is important to rely on qualified experts to help properly develop a supportable value estimate. Depending on the circumstances, there may be risk to pushing too far in either direction. Wise founders will secure proper guidance in the process.

Building a technology company from the garage, dorm or apartment to a multi-billion-dollar business takes enormous vision, tremendous management, a superior, innovative product and usually a bit of good fortune, or at least the right backers. Growing an equity-funded company requires the ability to convince investors to take a risk with their capital, with the aim of achieving a significant return over time. Developing a defensible valuation at key points along the way is one critical element of becoming the next notable venture-funded startup story.

 

Kemp Moyer is a Director in the Advisory practice at BPM, one of the 50 largest accounting and advisory firms in the country. With more than 15 years of experience in complex financial advisory matters, he oversees growth and development of the Firm’s Valuations and Appraisals practice.